Legislature(2005 - 2006)SENATE FINANCE 532
07/13/2006 09:00 AM Senate SPECIAL COMMITTEE ON NATURAL GAS DEV
| Audio | Topic |
|---|---|
| Start | |
| SB3001 || SB3002 | |
| Bill Corbus, Commissioner, Department of Revenue | |
| Robynn Wilson, Department of Revenue | |
| Dan Dickinson, Cpa, Consultant to the Governor | |
| Dr. Pedro Van Meurs, Consultant to the Governor | |
| Roger Marks, Economist, Department of Revenue | |
| Ken Griffin, Deputy Commissioner, Dnr | |
| Presentation on Access to the Gas Pipeline and Basin Control | |
| Bob Loeffler, Morrison and Foerster, Consultant to the Governor | |
| Ken Griffin, Deputy Commissioner, Dnr | |
| Donald Shepler, Greenberg Traurig, Consultant to the Legislature | |
| Rick Harper, Econ One Research, Inc., Consultant to the Legislature | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| *+ | SB3001 | TELECONFERENCED | |
| *+ | SB3002 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
ALASKA STATE LEGISLATURE
SENATE SPECIAL COMMITTEE ON NATURAL GAS DEVELOPMENT
July 13, 2006
9:16 a.m.
MEMBERS PRESENT
Senator Ralph Seekins, Chair
Senator Lyda Green
Senator Gary Wilken
Senator Fred Dyson
Senator Bert Stedman
Senator Lyman Hoffman
Senator Donny Olson
Senator Thomas Wagoner
Senator Ben Stevens
Senator Albert Kookesh
Senator Kim Elton
MEMBERS ABSENT
Senator Con Bunde
OTHER LEGISLATORS PRESENT
Senator Gary Stevens
Senator Gene Therriault
Senator Charlie Huggins
Representative Mike Kelly
Representative Eric Croft
Representative Ralph Samuels
Representative Kurt Olson
Representative Paul Seaton
COMMITTEE CALENDAR
SENATE BILL NO. 3001
"An Act relating to the production tax on oil and gas and to
conservation surcharges on oil; relating to criminal penalties
for violating conditions governing access to and use of
confidential information relating to the production tax;
amending the definition of 'gas' as that definition applies in
the Alaska Stranded Gas Development Act; making conforming
amendments; and providing for an effective date."
HEARD AND HELD
SENATE BILL NO. 3002
"An Act relating to the Alaska Stranded Gas Development Act;
relating to municipal impact money received under the terms of a
stranded gas fiscal contract; relating to determination of full
and true value of property and required contributions for
education in municipalities affected by stranded gas fiscal
contracts; and providing for an effective date."
HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: SB3001
SHORT TITLE: OIL/GAS PROD. TAX
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
07/12/06 (S) READ THE FIRST TIME - REFERRALS
07/12/06 (S) NGD
07/13/06 (S) NGD AT 9:00 AM SENATE FINANCE 532
BILL: SB3002
SHORT TITLE: STRANDED GAS AMENDMENTS
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
07/12/06 (S) READ THE FIRST TIME - REFERRALS
07/12/06 (S) NGD
07/13/06 (S) NGD AT 9:00 AM SENATE FINANCE 532
WITNESS REGISTER
WILLIAM A. CORBUS, Commissioner
Department of Revenue
PO Box 110400
Juneau, AK 99811-0400
POSITION STATEMENT: Presented SB 3001.
ROBYNN WILSON, Director
Tax Division
Department of Revenue
PO Box 110400
Juneau, AK 99811-0400
POSITION STATEMENT: Presented SB 3001 and answered questions.
DAN DICKINSON, CPA
Consultant to the Governor
Office of the Governor
PO Box 110001
Juneau, AK 998811-0001
POSITION STATEMENT: Gave a presentation and answered questions
relating to SB 3001.
DR. PEDRO VAN MEURS
Consultant to the Governor
Office of the Governor
PO Box 110001
Juneau, AK 00911-0001
POSITION STATEMENT: Testified on SB 3001.
ROGER MARKS, Economist
Department of Revenue
PO Box 110400
Juneau, AK 99811-0400
POSITION STATEMENT: Discussed differences between a gross tax
and a net tax relating to SB 3001.
KEN GRIFFIN, Deputy Commissioner
Department of Natural Resources
400 Willoughby Avenue
Juneau, AK 99801-1724
POSITION STATEMENT: Answered questions on SB 3001 and spoke
briefly during the discussion of access to the gas pipeline and
basin control.
JIM CLARK, Chief Negotiator
Office of the Governor
PO Box 110001
Juneau, AK 99811-0001
POSITION STATEMENT: Presented information on access to the gas
pipeline and basin control.
BOB LOEFFLER
Morrison and Foerster
Consultant to the Governor
Office of the Governor
PO Box 110001
Juneau, AK 00911-0001
POSITION STATEMENT: Presented information on access to the gas
pipeline and basin control.
REPRESENTATIVE RALPH SAMUELS
Alaska State Legislature
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Asked questions relating to access to the
gas pipeline and basin control.
SENATOR GENE THERRIAULT
Alaska State Legislature
Alaska State Capitol
Juneau, AK 99801-1182
POSITION STATEMENT: Expressed concerns on issues relating to
access to the gas pipeline and basin control.
DONALD SHEPLER
Greenberg Traurig, LLP
Consultant to the Legislature
POSITION STATEMENT: Discussed issues relating to access to the
gas pipeline and basin control.
RICK HARPER
Econ One Research, Inc.
Consultant to the Legislature
Three Allen Center, Suite 2825
333 Clay Street
Houston, TX 77002
POSITION STATEMENT: Discussed issues relating to access to the
gas pipeline and basin control.
ACTION NARRATIVE
CHAIR RALPH SEEKINS called the Senate Special Committee on
Natural Gas Development meeting to order at 9:16:52 AM. Present
at the call to order were Senators Albert Kookesh, Fred Dyson,
Bert Stedman, Gary Wilken, Lyda Green, Thomas Wagoner, Ben
Stevens, Kim Elton, Donny Olson, Lyman Hoffman and Chair Ralph
Seekins. Also in attendance were Senators Gary Stevens, Gene
Therriault and Charlie Huggins, and Representatives Mike Kelly,
Eric Croft, Ralph Samuels, Kurt Olson and Paul Seaton.
SB 3001-OIL/GAS PROD. TAX
SB 3002-STRANDED GAS AMENDMENTS
CHAIR SEEKINS opened the hearing on SB 3001 and SB 3002, which
included a presentation on access to the gas pipeline and basin
control. He invited Commissioner Bill Corbus and Ms. Robynn
Wilson to present SB 3001.
9:17:44 AM
^Bill Corbus, Commissioner, Department of Revenue
WILLIAM A. CORBUS, Commissioner, Department of Revenue, informed
members he was appearing on behalf of the administration in
support of this petroleum production tax (PPT) legislation,
proposed to replace the broken tax system currently based on the
economic limit factor (ELF). It would provide incentives for
badly needed investment; special incentives for small companies
to explore Alaska; and increased revenues, especially at higher
prices. He specified that the governor and his administration
strongly support the PPT tax as proposed, the "20/20" - with a
20 percent tax rate and a 20 percent tax credit - and don't
support a gross tax.
He highlighted the need to encourage investment and resultant
oil production. Commissioner Corbus said the Trans-Alaska
Pipeline System (TAPS) now operates at less than 50 percent of
capacity. Recent investment, development and production have
been inadequate. Predicting that higher tax rates will
discourage new investment, he cautioned against emphasizing
short-term state revenues instead of long-term wealth. He
opined that the 20/20 formula is appropriate to arrest this
trend, but said although the PPT includes investment incentives,
the stronger link for investment is the tax rate.
He emphasized that high oil prices eventually will drop.
Combined with lower production, this will mean substantially
lower revenues. Commissioner Corbus closed by saying investment
is attracted not by price, but by how Alaska's fiscal regime and
geology compare with other opportunities around the world.
9:22:45 AM
^Robynn Wilson, Department of Revenue
ROBYNN WILSON, Director, Tax Division, Department of Revenue
(DOR), brought attention to a matrix comparing different tax
methods under consideration: the governor's bill, Version A;
the conference committee substitute (CCS) for SB 2001 from the
last special session; and, for informational purposes, the
versions of SB 2001 that passed the Senate and House. She noted
the governor's bill maintains the same regions of the state:
the Alaska North Slope (ANS); Cook Inlet, where oil and gas each
still have a separate rule; and other "south" developments.
Ms. Wilson said the governor continues to believe 20 percent is
the appropriate tax rate for a balanced fiscal system, with a
credit rate of 20 percent that she hadn't put on the matrix
because it was fairly constant throughout the versions.
She explained that the tax on Cook Inlet oil and gas has a
ceiling and can never be above the ELF rate. In the governor's
bill there is no progressivity, and credits for annual loss are
at 20 percent - when a loss coming forward is converted to a
credit, it is done at that tax rate. Neither is there a tax
floor. Ms. Wilson reported that the CCS, by contrast, has a
credit-usage floor such that capital expenditure (CAPEX) credits
cannot reduce the tax below 3 percent of the gross. She
referred to the line labeled "Gas (GRE)" and said it isn't
applicable under the governor's bill, but remains on the matrix
because it was in the version that passed the Senate. Ms.
Wilson indicated the transitional investment expenditures (TIE)
credit is for the last five years' capital expenditures brought
forward.
She pointed out that consistent with the last several versions
is a two-for-one provision, maintained from the CCS. The base
allowance credit, still $12 million, equates to a $60 million
deduction under the governor's bill. Originally that was a
deduction; throughout the matrix, therefore, Ms. Wilson said she
has shown an equal amount in terms of a deduction. It depends
strictly on the tax rate. The tax rate is different in the CCS
version, although the credit is the same; hence the equivalent
deduction is different.
She noted that is also based on production, maintaining the CCS
language; also maintaining that language is the new-area
development credit, $500,000 a month, for areas other than Cook
Inlet or the North Slope, with a 10-year rolling sunset. Oil
spill language and the 10-month transition period are consistent
with the CCS. Furthermore, the April 1 effective date is
consistent with the last several versions. Ms. Wilson offered
to answer questions on other bill sections.
9:30:00 AM
SENATOR OLSON asked: If the numbers are essentially the same as
previous versions, what makes the administration optimistic that
this will pass?
MS. WILSON opined that as more information is explored and
explained, it becomes increasingly clear that 20 percent is the
correct tax rate. Referring to discussion of the PPT with
respect to the contract, she pointed out that in the original
legislative session, the contract hadn't been made public; in
the first special session, people hadn't had much time to look
at it.
SENATOR OLSON reported that in his travels throughout the state,
he has found this less palatable to the public than when it
first was proposed.
SENATOR BEN STEVENS said he has found the exact opposite and
believes it is a question of political opinion.
CHAIR SEEKINS surmised most people are interested in trying to
get gas to market. However, he characterized SB 3001 as stand-
alone legislation, not part of a particular gas line project.
He suggested keeping questions out of the political arena as
much as possible.
9:33:46 AM
SENATOR ELTON asked what the administration's objection would be
to a gross tax structured to bring in an equivalent amount of
revenue.
MS. WILSON deferred to Mr. Dickinson to give a presentation, but
opined that a net tax encourages investment, which is needed to
boost production.
CHAIR SEEKINS asked Mr. Dickinson what precisely is meant by a
net tax or gross tax, and why the administration continues to
propose a net tax.
9:35:54 AM
^Dan Dickinson, CPA, Consultant to the Governor
DAN DICKINSON, CPA, Consultant to the Governor, noted he is
former director of DOR's Tax Division and its Oil and Gas Audit
Division. He provided a four-page document he'd prepared, "Net
vs. Gross Oil Tax - Why anyone should care," dated 7/10/06, as
well as a graph labeled "ANS West Coast Price & Oil Production."
Mr. Dickinson pointed out whereas 2 million barrels a day once
went into TAPS, the amount has declined over 18 years and now is
less than 900,000 barrels a day; this trend affects jobs and
revenue in the state. However, revenue has risen dramatically
over the last two years because of prices. He explained that a
net tax makes investment more attractive because there is a tax
break for investing; for more difficult projects, with higher
costs, the taxes are lower. A gross tax doesn't reflect the
costs and investments necessary.
SENATOR DYSON observed that one way to incentivize investment
for expensive oil under a gross-tax system can be royalty
relief. He asked Mr. Dickinson to provide an historical
perspective in traditional oil fields worldwide and in Alaska,
and to address whether it is a viable option for the producers
to go through the process of petitioning for royalty relief for
difficult or expensive oil production.
MR. DICKINSON replied that the oil and gas production tax is the
state's largest single tax. Until 2000, it was the largest
source of general fund dollars; because the ELF has eaten away
at it every year, however, royalties now take that position.
Most places in the world have one dominant way that wealth from
oil and gas resources is shared with the government - a
production share, a tax without a royalty or a royalty without a
tax. In Alaska, however, probably there should be both a
royalty and a tax in order to provide effective incentives.
Noting Ken Griffin of the Department of Natural Resources (DNR)
would be there later, Mr. Dickinson said he himself didn't know
about royalty relief for heavy oil in particular, but knew about
royalty relief in other situations.
9:43:59 AM
SENATOR DYSON related his understanding that royalty relief has
worked in Cook Inlet, but the process is cumbersome and doesn't
work well from the producers' perspective. He asked whether it
is unduly burdensome from the state's perspective.
MR. DICKINSON acknowledged he hadn't studied this issue
thoroughly, but opined that when the royalty-relief process was
set up, it had a fairly high standard that must be met: DNR
must be able to demonstrate royalty relief will bring about the
desired result. He surmised this is difficult and burdensome to
meet, and deferred to someone from DNR such as Ken Griffin for
further response.
9:46:16 AM
SENATOR BEN STEVENS asked Dr. Pedro van Meurs whether his
presentation at Centennial Hall in May had included the
following: Alaska has the only regime with both royalty and
severance tax, and when other regions grant royalty relief, they
don't have a severance system that backs it up.
9:48:02 AM
^Dr. Pedro van Meurs, Consultant to the Governor
DR. PEDRO VAN MEURS, Consultant to the Governor, affirmed that.
He clarified that internationally there normally aren't
severance taxes; those are a unique U.S. feature. He said a
number of countries have royalty relief to make royalties more
flexible, including Canada with its oil sands and Columbia and
Venezuela with their heavy oils. In addition, there are sliding
scales linked to production and so forth. A number have some
form of royalty relief for heavy oils, long-distance gas or
local wells or fields.
SENATOR BEN STEVENS emphasized the complexity of the tax system
in Alaska and North America. Saying there hadn't been adequate
information disseminated in this regard, he surmised the public
believes this system under AS 43.55 is the only tax system in
place. However, there are five systems: 1) bonus bidding on
the lease itself; 2) royalty, never changed on the North Slope
and not proposed for change; 3) severance tax, being changed;
4) property tax; and 5) corporate income tax. He characterized
it as the state holding five levers attached to the purse
strings of the oil companies and yet only pulling one; he said
people are concerned that the one isn't being pulled hard
enough, and they forget about the other four, which offer no
incentives.
MR. DICKINSON thanked him for that insight, agreeing this is new
information for citizen groups.
CHAIR SEEKINS reported that has been his experience as well.
9:51:07 AM
SENATOR STEDMAN noted many Alaskans are concerned that
companies' records will be manipulated under a net-tax system
and thus the taxes collected by the state will be lower than
anticipated. He said the proposed tax will rely on Internal
Revenue Service (IRS) regulations with respect to inclusion of
allowable expenses and capital expenses. He asked whether it is
correct that if the books were altered to drive apparent income
down, that would likely violate federal Securities and Exchange
Commission (SEC) and IRS laws and regulations.
MR. DICKINSON answered that he believes, in general, there
already are fairly strict criminal penalties for misreporting
amounts for tax purposes. Noting companies keep separate
accounts for tax and financial records purposes, he opined that
Sarbanes-Oxley and the associated strictures that apply to
financial accounting don't extend into the tax world.
Mr. Dickinson said he would provide five reasons why the concern
about being snookered is invalid, and would give a presentation
to put those expenses into perspective.
9:53:40 AM
MR. DICKINSON offered his first point: "Net versus gross" isn't
a totally accurate depiction. Rather, the state is just
substantially increasing the pool of costs that the taxpayer can
deduct and which the state must then audit and check. A gross-
receipts tax typically is based on what something is sold for,
for example, without deductions. Under the current method,
however, "gross value at the wellhead" comes from selling it in
Los Angeles and deducting close to $2 billion in costs between
there and the point at which it is measured. It's not a pure
system with a simple number that can be looked up; billions of
dollars' worth of costs are deducted under the system.
Similarly, "net" typically means all costs are deducted, and yet
several pages in this legislation specify costs that aren't
deductible, in order to limit them to specific areas.
He addressed his second point: DOR already has audited many of
these costs. For example, from 1979-1981 the state had separate
accounting income tax, and all these costs had to be audited by
DOR. In addition, net profit share leases (NPSLs) were audited
by DOR. Relating his third point, Mr. Dickinson said capital
costs make up the largest portion of the costs. Having a gross
tax and allowing capital credits doesn't avoid auditing, since
it already is required.
He discussed his fourth point: Historically, billions of
dollars in the Constitutional Budget Reserve Fund (CBRF) came
about as a consequence of disputes being resolved. There have
been huge disputes, Mr. Dickinson told members, some relating to
royalties, but primarily relating to taxes. Those issues can be
grouped into two areas: valuation and costs. Elaborating on
valuation issues, he recalled that during the era of price
controls and no transparent spot prices announced on the markets
every day, there were huge differences with respect to the value
of crudes; this was in 1981-1982, but the amounts didn't go into
the CBRF until 1996. He noted that experts could differ as to
the value of a barrel of oil by as much as $25 a barrel.
9:58:21 AM
MR. DICKINSON continued with valuation issues, saying although
there still are disputes, they are about 10 cents and 15 cents,
relating to premiums and deductions based on transparent spot
prices. Thus that whole set of billion-dollar issues is off the
table.
He turned to costs, noting such issues haven't related to
audits, for instance, but have been differences of opinion on
transparent issues such as depreciation, return on investment or
allocation of overhead. Costs weren't being hidden or
manufactured. Although at one point the state alleged fraud, he
said those allegations were withdrawn and no fraud was proven.
Looking at the history, including the Amerada Hess case and the
litigation which created the $7 billion set of settlements in
the CBRF, Mr. Dickinson discounted the idea that the earlier
scenario would return.
He offered his fifth point: The state has an 11 percent
interest rate. If a later audit finds a company has been too
aggressive, the company will pay high amounts of cumulative
interest on the difference. That rate was put in to try to
resolve some large outstanding amounts at the time, and it
specifically exists to try to keep self-reporting in line with
what the state wants to see. Mr. Dickinson concluded by again
disagreeing that the state will be snookered and somehow will
head into murky waters that will cost billions of dollars in tax
revenues, for all the aforementioned reasons.
10:00:45 AM
SENATOR STEDMAN requested discussion about the whole accounting
cycle of a field or particular drilling venture, and the fact
that amortization and depreciation loaded on the front end are
subsequently lost on the back end.
MS. WILSON pointed out there are tensions - which are a good
thing - for bookkeeping purposes. Any manipulation generally
will be to drive up income, since companies want to present
financial statements in the best possible light; there are
rules, and independent accountants go in and ensure those are
properly stated. The other side of the tension is for tax
purposes: companies look for ways to legally take advantage of
the tax code in order to show a lower income.
She noted Schedule M-1 of the federal income tax return shows
the book/tax differences, item by item; it typically is the
first place auditors go to examine those differences between
book and tax. Generally, taxable income is lower than the book
income, but the question is why. It may be about depreciation,
and Ms. Wilson said there are numerous legitimate differences.
In the PPT, however, capital investments are written off on day
one; they aren't depreciated. This is specifically to encourage
investment. That book/tax difference won't be audited for PPT
purposes because it isn't applicable and there was a policy
consideration behind it. She deferred to Mr. Dickinson for
further explanation.
10:04:56 AM
SENATOR STEDMAN reiterated his desire to show the public the
ramifications through the full accounting cycle when the state
gives up revenue at the beginning under a net-tax system.
MR. DICKINSON replied that a frequent issue is timing. There
are real economic effects from being able to take a loss or
receive tax benefits when the money is spent. If a producer
comes in new, the IRS will say - with certain exceptions - that
costs cannot be recognized until there are revenues, and the
income can be lowered a little each year over the useful life of
that asset. To encourage investment and the resulting economic
benefits, however, the state is saying all that investment can
be taken up front, which provides the "time value" of the money
from the tax break at the beginning. In the out years,
consequently, higher revenues will be taxable. In contrast, the
IRS and SEC attempt to match the effect of the costs with the
revenues derived from those costs.
10:07:46 AM
MR. DICKINSON, in further response, said royalties, income taxes
and property taxes would accrue as well. He emphasized making
active investment more attractive through the net-tax system,
particularly with dollars generated from profits within Alaska
already, thus keeping the money in Alaska for reinvestment
because of the tax advantage. Under a gross tax, by contrast,
money earned in Alaska can be invested anywhere in the world
without affecting the taxes. That is the distinction this
legislation tries to address. In response to Senator Dyson, he
agreed some historical problems have been solved, but said
companies properly spend a lot of effort on tax-planning
opportunities.
SENATOR DYSON asked whether they are tax-avoidance
opportunities.
MR. DICKINSON pointed out that if there are rules, a company
must follow those. He also indicated that if the desire is to
provide incentives, a line must be straddled by the state,
trying to not distort the economics but positively affect them.
The vast majority of decisions that companies make are looked at
and appear to make sense; the state doesn't even look at those
every year. The focus is on the small number where there is a
challenge.
He provided details of his history working on tax issues and
settlements. Mr. Dickinson observed that the areas for dispute
have narrowed considerably, especially with respect to
valuation. If a new set of costs is brought in, new issues will
arise and the state will try to narrow those down; however, he
offered his belief that those couldn't possibly rival the kinds
of dollar-per-barrel issues that arose during the late 1970s and
early 1980s, when there were price-control issues. He concluded
by saying the answer to Senator Dyson's question was yes.
10:14:40 AM
SENATOR DYSON expressed hope that the front-end credits will
simplify the accounting as well as provide great incentive. He
asked whether the administration has quantified and studied the
range of those credits. He reported hearing that the high side
of credits for the industry might approach $13 billion.
MR. DICKINSON affirmed it has been quantified and studied. He
pointed out that the analyses do consider the credits. While
$13 billion - if that's the right number - sounds like a lot, he
surmised everyone agrees it is worthwhile if it's part of the
investments.
SENATOR DYSON said he'd like to see the administration's
numbers.
MR. DICKINSON replied that if there is $1 billion in investment
a year, for instance, with a 20 percent credit and 20 percent
deduction, that is 40 percent or $400 million a year - about
$13 billion over 30 years, which in broad strokes sounds about
right. At today's prices, it would bring in over $100 billion.
Interpreting Senator Dyson's concern to be that this might not
work out in practice, Mr. Dickinson suggested that Dr. Pedro van
Meurs speak about the frequency with which net taxes and credits
for investment are used as tools internationally.
10:18:42 AM
DR. VAN MEURS pointed out that Alaska already has a highly
important feature that collects half the royalties, which are
based on gross. The decision was made that combining two
systems based on gross would be negative to an investment
climate, and would hit very hard all the marginal fields, heavy
oils and so forth when prices are low. Dr. van Meurs reported
almost 100 nations have royalties, and most nations recognize
the benefit of collecting a significant share of income from a
gross feature like royalties. About 70 nations believe anything
in addition to a royalty must be profit-based. If costs are
high or prices are low, having two systems based on gross
doesn't work effectively.
He emphasized the desirability of a total package with one
feature based on gross and another on net. Dr. van Meurs said
the system based on gross gives protection when prices are low,
providing at least a minimum amount of income no matter what,
and the net feature provides benefits when prices are high.
Nothing stops Alaska from asking for 20 percent royalties on new
leases if prices stay high; thus Alaska is well served with a
good royalty system.
He related his international experience that, yes, companies
might overcharge now and then or slip something in. However,
that is the reason for having auditors, and Alaska is better
prepared in this respect than other places using a net system.
Dr. van Meurs said governments seem to reasonably collect what
needs to be collected - even governments far less skilled than
the State of Alaska. Thus he denied the possibility that major
amounts of money could be siphoned off. Apart from that, the
rules contained in the law are patterned on the best rules in
the world; it isn't an open-ended system.
10:24:08 AM
DR. VAN MEURS opined that all possible loopholes have been
closed, including ones through which other nations sometimes
lose money, and that the system can be administered well.
However, he then acknowledged something always slips through the
cracks, but said on balance it will be a good opportunity to
create high revenues if economic conditions are favorable. Most
important, the 70 nations using similar systems have concluded
this formula encourages reinvestment in the same jurisdiction;
otherwise, investors will naturally take their capital to where
they get the deductions.
He said that's why it is so important to combine the system
based on gross - the royalty that will continue to serve Alaska
well - with one based on net, which will serve Alaska well in
the future. Dr. van Meurs indicated other options were looked
at, including sliding scales for a gross tax and improvements to
the ELF, even by the previous administration. For the
aforementioned reasons, however, and because it is difficult to
design a simple system based on gross that captures all these
variables, it was decided to base this on net.
SENATOR DYSON asked how well it has worked for regimes to give
large investment credits on the front end, hoping to incentivize
further investment and production, with greatly increased
revenues resulting in the out years.
DR. VAN MEURS replied that typically, in other regimes, the
concept of a cash flow-based system as proposed here, rather
than one based on depreciation, has worked well. Of the 70
nations he'd mentioned, the vast majority have such a system.
If capital is invested, 100 percent of the deductions - plus, in
this case, the credits - are taken in the year that costs are
incurred. This creates an enormous incentive to reinvest; in
most countries using that system, it has resulted in significant
investment. Pointing out that Alaska has 5 billion barrels of
heavy oil and yet remarkably low activity compared with other
areas in the world, he lauded features of the proposed PPT
legislation and suggested focusing on new investment, since more
oil will increase revenues.
10:31:04 AM
SENATOR ELTON said he understands the arguments, but asked why
it is simpler to create a whole new way of doing things instead
of duplicating what is being done under royalty with gross,
without the ELF component. Highlighting the importance of
Mr. Dickinson's graph that shows production declining and prices
rising, he said it seems there could be a two-for-one clawback
under gross as well as under net, which would get to the issue
raised in the graph.
DR. VAN MEURS agreed a simple system would be to just forget the
production tax and add another 12.5 percent royalty. Venezuela
did something similar in 2002; Venezuela is on tidewater,
however, has costs of $2 or $3 a barrel and is near the market.
In Alaska, by contract, there are light and heavy oils as well
as a large distance for transportation; such a system would hit
the heavy oils and smaller fields so much that nobody would be
interested in them. If the price dropped, the oil industry
would come back to the legislature and ask for a lower rate.
Thus it wouldn't work economically in Alaska.
He noted the ELF worked well for a number of years, and
theoretically could be modified to be more sophisticated,
formula-based system based on the gross. However, it would have
many friction points such as defining what a field is or what
heavy oil is. It would become so difficult to administer from a
technical standpoint that it would fall apart. Dr. van Meurs
indicated this is why the ELF system became broken.
He offered his sense that a simple net system that automatically
takes into account these variations, without having to define
them or set formulas or sliding scales, is easier to administer
than a sophisticated system based on gross. While an
unsophisticated system like Venezuela's is easier still, Dr. van
Meurs opined that it would ruin the oil industry in Alaska at
prices under $40. Thus he stated his belief that the proposed
PPT system is simpler than a formula-based system on gross for
the production tax.
10:38:29 AM
SENATOR STEDMAN highlighted the concern that as prices rise
under the current system, the state's percentage declines. He
said one drawback to the gross-based system is it doesn't
address it without including so-called progressivity. Whatever
system is instituted needs to ensure that as prices rise, the
percentage either rises or stays the same, to protect the
interests of the people of Alaska.
CHAIR SEEKINS expressed the need to define "net" and the
proposed deductions in order to address concerns among his
constituents, who believe a gross-tax system is much simpler.
The committee took an at-ease from 10:41:42 AM to 1:29:30 PM.
MS. WILSON illustrated gross versus net through an analogy
involving a construction business. The net is calculated using
direct expenses associated with each home, including nails,
lumber and wages; that is akin to lease expenditures in SB 3001.
Once the homes are built, however, the company has expenses that
cannot be tied to a particular home, including marketing
expenses or contributions to the Little League. If a house is
sold, a tax on gross would take the sales price times the tax
rate, without deductions. A net tax - including the PPT - is
calculated after the allowable deductions, which in this case
would include nails, lumber and wages, but not advertisement
costs or donations to the Little League.
1:33:59 PM
MR. DICKINSON turned the focus to Alaska. He showed a series of
slides, duplicated in a handout, that approximate what a PPT
would have done in 2005. He told members the first slide, "Sale
at Market," shows an outdated price of about $43 a barrel; if
the 300 million barrels were sold this year for $70 a barrel,
the total of $14.5 billion for North Slope oil instead would be
$21 billion. This is the value of the oil in the marketplace
prior to deducting any costs. Mr. Dickinson noted the slide
also shows Cook Inlet oil and gas, and North Slope gas.
He addressed the second slide, "Gross Value at Point of
Production." Mr. Dickinson explained that this shows what is
done today, subtracting the cost of transporting it to market
from the North Slope or Cook Inlet; the roughly $1.7 billion is
a fairly small percentage overall. Under the current method, a
percentage is taken of what remains; however, what it costs to
get the oil to the wellhead or to get it ready to transport
isn't an allowable deduction. In response to Chair Seekins,
Mr. Dickinson agreed this is as adjusted by the current ELF. He
added that even though the nominal tax rate is about 15 percent,
once the ELF is figured in and barrels are taken out, the amount
taken would be about 7 percent of the orange area on the chart,
which depicts $14.5 billion for North Slope oil.
1:37:39 PM
MR. DICKINSON showed the third slide, "Net Value or Production
Tax Value." He pointed out that among the deductions the
producers should be allowed to take is $1.7 billion in capital
costs - investments needed to continue to get oil out of the
ground - and $1.1 billion in operating costs on the North Slope.
While there will be an increase in the amount audited - compared
with the $1.7 billion for transportation to market, discussed
previously and also shown on this chart - it is a question of
degree, since auditing has been required all along and people
have always been required to calculate expenses.
He also noted there are different companies. Some might have a
lot of heavy oil in their portfolio and thus higher capital
costs. Under a net system, the amount taxed would shrink; with
a gross system, Mr. Dickinson said, it would be identical to
someone who had production from the Prudhoe Bay reservoir at low
cost and didn't have to make many more capital investments.
He addressed concerns about clever schemes. Mr. Dickinson
indicated a company would have to somehow show capital costs
five times higher than in reality, which isn't what happens.
The larger piece, $14.5 billion from North Slope oil, wouldn't
be wiped out from some item in the operating costs, capital
costs or transportation-to-market categories. Mr. Dickinson
reiterated that the slide shows $40 a barrel; if the price were
higher or lower, it would affect those amounts. Even so, the
total dollars spent getting the oil up and out and to market
wouldn't come anywhere near the total value.
He showed the fourth slide, also labeled "Net Value or
Production Tax Value," with a checkered area depicting a
22.5 percent tax. Noting the governor has suggested it should
be 20 percent, Mr. Dickinson explained that this is what the
state would take in production tax, simply a percentage of the
$14.5 billion for North Slope oil. The remaining portion is
used by a producer to pay royalties, property taxes and income
taxes to the state; to pay federal taxes; to pay back any
borrowed money for capital costs or investments; and to show a
return to shareholders. He emphasized that a small shift in the
capital cost or operating cost piece won't wipe out the tax.
1:41:52 PM
MR. DICKINSON showed the fifth slide, "Tax Before Credits."
He told members that had the PPT been in place, at these current
values the checkered portion on the previous slide would have
been $2.4 billion. He then showed the sixth slide, "Tax After
Credits," which depicts tax after credits at $1.7 billion. As
to whether the tax will be wiped out if someone finds a way to
show larger credits, he said no. This graph shows the period of
the "5,000-barrel equivalent," and has a bar labeled "5,000 bbl
equivalent credit, 8 users at max of 14 million - 112 million."
He said this is about the size of that credit in relation to the
total taxes against which the credits are being taken.
He turned to the transitional investment expenditures, depicted
on the same slide as "TIE credit 1.7 x .5 x .2 - 170 million."
Mr. Dickinson explained, in response to Chair Seekins, that the
TIE portion of SB 3001 looks at investments made for five years
prior to when the legislation comes into effect; producers are
allowed to get a credit for those, provided they can match it
with new dollars being spent. If a producer is in a "harvest"
mode and not spending new dollars, there is no TIE. If a
producer increases expenditures by about 40 percent - so they're
about 140 percent of what they were - the full TIE can be
claimed in the first seven years of the legislation.
He noted the other piece shown is the direct qualified capital
expenditure credits. Mr. Dickinson indicated the previous
Senate bill had those at 25 percent, whereas the governor's bill
is at 20 percent; thus that bar on the slide would be a little
smaller. Mr. Dickinson made the point that if someone comes up
with a different way of doing credits, it won't wipe out the
entire tax burden; it is small in relation to the totals.
He presented the final slide, showing information from the sixth
slide - including tax after credits at $1.7 billion - as well as
a new box depicting the tax under the status quo at about
$0.9 billion. Mr. Dickinson pointed out that if legislators
accept what the administration and a number of experts have
said, this tax will create incentives for further production and
investment. Whereas under the existing ELF it would collect
about $0.9 billion, the system with credits and a higher rate -
even with quite a bit of movement in the other categories -
would still give a better result than the status quo.
1:45:00 PM
MR. DICKINSON encouraged legislators to not let concerns about
how to administer this overwhelm the economic considerations.
If the state is helping to make investment more attractive
through the tax system, he surmised more investment will happen,
which is really all a net tax is doing.
CHAIR SEEKINS returned to the third and fourth slides, showing
$1.1 billion in operating costs and $1.7 in capital costs. He
requested confirmation that these costs would be directly
attributed to North Slope operations, with no way a company
could use deductions from another state or nation against taxes
owed under this system.
MR. DICKINSON affirmed that, but pointed out that if BP had a
technical problem with heavy oil on the North Slope, for
example, and the best lab to resolve it was its own lab
overseas, it would be charged internally against the North
Slope. In further response, he indicated losses carried forward
from elsewhere wouldn't affect the North Slope operation.
CHAIR SEEKINS noted his constituents are concerned that
deductions applied against taxes in Alaska will be company-wide
expenses, such as a bonus paid to the chief executive officer.
He surmised those would be deductible in terms of state income
tax, but not the severance tax or whatever this will be called.
1:48:04 PM
MR. DICKINSON concurred. He mentioned the structuring of the
bill and pointed out that in the Prudhoe Bay Unit, BP does the
check writing and hiring. However, BP only has a 26 percent
interest, and so only 26 cents of every dollar actually comes
from its pockets. ExxonMobil and ConocoPhillips each have
something over one-third; some of their employees do nothing but
look over BP's shoulder and say, "We're not going to spend this,
we're not going to spend that." Mr. Dickinson suggested any
bonus to Lord Browne of BP would catch their attention.
Furthermore, the state could say that one test which must be
passed is that the other partners must have been willing to pay
for it; then the state would apply its own tests.
CHAIR SEEKINS asked whether deductions for operating costs and
capital costs, particularly the latter, are limited to actual
dollars spent, rather than reclassification of the asset. For
example, if an oil-producing well is converted to a gas well,
can it be recapitalized at that point for what it would cost to
install a gas-producing well? Or does it not qualify as a
capital cost in terms of deductions because it already has been
spent and recaptured other ways?
MR. DICKINSON said it is a good question. One test in the PPT
for a capital cost is whether it could have been capitalized on
the federal tax return. He noted additional dollars at the time
of conversion might apply, but indicated the IRS guards against
arguments when companies show a series of invoices in order to
prove a transaction carries weight that it perhaps shouldn't.
CHAIR SEEKINS reported hearing that Federal Energy Regulatory
Commission (FERC) rules might allow for rolling an already
deducted asset into that process. He said there is a lot of
suspicion that the State of Alaska might be gamed with respect
to the PPT as well.
MR. DICKINSON acknowledged this issue can arise. However, he
indicated the administration isn't looking at the rules of FERC,
which generally aims toward treating consumers fairly, but is
looking at those of the IRS, which generally doesn't allow a
deduction for depreciation more than once.
CHAIR SEEKINS summarized that these two deductible expenses -
capital costs and operation costs - are actual dollars spent
that are directly attributable to Alaska North Slope (ANS)
operations.
MR. DICKINSON affirmed that as the intention, noting it is
contained in several places, in several ways, in the PPT.
1:53:16 PM
SENATOR HOFFMAN inquired about other North Slope fields such as
the NPSLs in the Beaufort Sea; he mentioned Amerada Hess and
drilling that led to discovery of the Northstar field.
MR. DICKINSON said he would have to get specific information.
There may be an issue about an "affiliate charge" when an
affiliate comes in. Federal tax rules are looked at with
respect to who is spending that money; those rules might not
have been as clarified in the NPSL regulations. In general, the
costs will be allowed, and the only question that arises, from
the sound of it, is whether an Amerada Hess affiliate was doing
the drilling and then the costs were passed through to the
Amerada Hess affiliate in whose name the development account was
being kept.
SENATOR HOFFMAN asked whether that would be acceptable under
current regulations.
MR. DICKINSON answered it isn't done currently for production
tax. In the income tax rules that will come in, typically the
entire entity is looked at, and cross-selling between them "just
cancels itself out" if it's part of the unitary group. He
offered to respond further if Senator Hoffman provided more
specific information.
1:55:29 PM
CHAIR SEEKINS surmised a gross tax would drop some deductions
and would be applied at an earlier point and different rate.
MR. DICKINSON commended that observation, saying gross taxes
around the world typically are at a smaller rate, since the
numbers they apply to are larger.
CHAIR SEEKINS asked whether expenses that would end up in these
two categories - operating costs and capital costs - are already
published or otherwise available to the state. He noted both BP
and ConocoPhillips had published in their financial statements
their "operating profits" in Alaska.
MR. DICKINSON replied yes and no. Operating costs, which are
immediately deductible, are deducted annually, and the state
gets access to federal returns. In addition, in looking at the
PPT the state has pulled together statements from the Prudhoe
Bay Unit, for example, where the operator bills the owner. Each
is constituted as a separate partnership, and the state looks at
those partnership returns and the documents behind them. That
will also include cash calls for capital expenditures.
He pointed out that capital expenditures won't be seen in the
IRS returns until the asset is placed in service. There will be
reconciliations, but basically under the IRS rules if it takes
three years to develop an asset and there isn't any productive
income from it, none of it can be deducted until it is placed in
service; it has to be set aside and doesn't show up as either an
expense or a deduction. Mr. Dickinson said what a producer will
present to the IRS as a capital expense or an operating expense
won't be verifiable by the state until some years down the road.
He noted another way is through financial statements.
ConocoPhillips historically has broken out Alaska as a separate
area, and someone can go through the "M-1 exercise" to compare
financial statements with taxes. On something like operating
costs, Mr. Dickinson said it isn't controversial. However,
drilling expenses are treated differently under financial and
tax accounting. Thus there is access to information, and if it
could be provided through the PPT, it would be available all in
one piece.
1:59:38 PM
CHAIR SEEKINS asked if there are federal penalties for
misrepresentation on a company's financial statements.
MR. DICKINSON replied yes. The rules that would apply are SEC
rules and civil fraud that would arise from misstating a
financial accounting document. Under SEC rules, which to his
belief follow financial accounting rules, a business must show
whether each segment has a material effect, as it is defined;
misstating that is misstating part of the financials. He
indicated ExxonMobil uses the segment rules, and the Alaska
piece wouldn't have a material effect on its performance; the
same isn't true for ConocoPhillips. "That's why some companies
do and some companies don't," he added.
CHAIR SEEKINS asked whether there is access to the capital costs
if there is only a single entity.
MR. DICKINSON answered no, although those expenses could be
found in the federal income tax return if one looked deep
enough. He added that companies like to share risk, so few sole
operations are found on the North Slope. Right now, BP operates
two fields - Milne Point and Northstar - that are the only
fields there without significant minority partners.
CHAIR SEEKINS asked whether the companies' accounting of
expenses would be available for the state for auditing purposes.
MR. DICKINSON affirmed that, noting they'd be available directly
from the IRS through cooperative agreements that the state has
entered into, and through the regular course of business. He
highlighted a tension that the PPT takes good advantage of: a
company wants to deduct expenses immediately, classifying them
as operating expenses, whereas the IRS forces capitalization of
expenses that will produce benefits over a period of time, and
allows incremental deductions accordingly.
2:04:24 PM
CHAIR SEEKINS asked Ms. Wilson whether DOR is able to determine
the amount of taxes owed under this system.
MS. WILSON replied yes. She noted DOR has people with
experience in auditing NPSLs and has income-tax auditors
familiar with IRS provisions and tax books. She related her
expectation that the information discussed by Chair Seekins,
including subledgers, would be provided through course-of-
business audit requests.
CHAIR SEEKINS indicated the commissioner, in Fairbanks, had said
a few more employees would be needed, at higher pay.
2:05:33 PM
MR. DICKINSON, in response to Senator Elton, said the
$1.7 billion in capital costs shown on the third slide
represents dollars spent in 2005 on the leases on the North
Slope and in Cook Inlet to get further development. They are
deductible "as they are being made" and don't include pipeline
costs or the kinds of expenditures seen for a gas line, other
than the ones for the lease.
He used the year 2009 as an example, as suggested by Senator
Elton. Mr. Dickinson explained that if there is a gas line,
there would be developments at Point Thomson. Although the
billions spent there would appear on the graph, neither the gas
line itself nor the gas-transmission plant would be shown. When
those are operating, they would flow into the operating costs;
they'd have been paid for out-of-pocket, going along. He said
not much would need to be done at Prudhoe Bay with respect to
capital costs. As to whether operating costs, shown in gold on
the graph, would increase in 2009, he suggested 2011 would be
more realistic.
CHAIR SEEKINS indicated that hopefully production will increase.
MR. DICKINSON pointed out that the graph shows 334 million
barrels, but this year fewer than 300 million would be produced.
Barring further capital investment, it is predicted to shrink
even further.
2:10:43 PM
^Roger Marks, Economist, Department of Revenue
ROGER MARKS, Economist, Department of Revenue, referenced a one-
page document showing light oil and heavy oil under a gross
system versus a net system. He explained the scenario shown,
with the West Coast ANS price at $30.00, until recently
considered high; shipping from Valdez to Los Angeles at $2.00;
and the tax tariff at $3.00. The gross value would be $30.00
minus the shipping and tariff, $25.00 at the lease boundary.
Both light oil and heavy oil are put into the pipeline and sold
as a mixture at the same price, Mr. Marks explained.
He pointed out that upstream costs differ, however. Mr. Marks
estimated light oil would cost about $7.50 to produce, including
both capital and operating costs; heavy oil would cost about
$15.00, since it is much more difficult to produce. The North
Slope has different classes of heavy oil, he noted, and the
number could be higher or lower. Light oil under this example
would have a net value of $17.50; heavy oil, $10.00.
He continued with the example. If a straight 15 percent tax on
gross were enacted and the ELF eliminated, it would be
15 percent of $25.00, or $3.75; this would be 37.5 percent of
the net value for heavy oil, Mr. Marks noted, whereas people
have been talking about a tax on net of 20 to 25 percent. Under
a gross system that doesn't differentiate upstream realities,
heavy oil, which needs the most help, would get the biggest
"kick in the stomach" under a simple gross tax like this.
CHAIR SEEKINS asked what the royalty would be at the West Coast
ANS price, on average. He gave the example of $30.00.
MR. MARKS replied that if this were West Sak in the Kuparuk
Unit, which he believes has about a 12.5 percent royalty, it
would be 12.5 percent of the gross amount of $25.00, for a total
of $3.13.
CHAIR SEEKINS surmised on heavy oil it would be under $7.00.
MR. MARKS noted the royalty would be deductible from the
severance tax, so it would be a little less.
CHAIR SEEKINS suggested these numbers might be a disincentive to
develop that field.
MR. MARKS cautioned that merely taxing on the gross to provide
simplicity ignores a very complicated problem: not all oil is
created the same.
2:17:50 PM
MR. MARKS turned to exploration economics, noting the main
drivers are geology and exploration costs. He said the question
is how the fiscal system can help to spur exploration. Because
TAPS is 60 percent empty, finding new oil is important. The tax
rate on oil doesn't have that big a role in exploration
economics because no tax is paid if it comes up dry, which
happens most of the time. There is a 100 percent chance of
incurring exploration costs, but if there is only a 5 percent
chance of success, the tax rate from finding oil only comes into
play only 5 percent of the time.
He said while the state cannot affect geology directly, it can
share the dry-hole risk and thus affect costs by sharing them.
Mr. Marks recalled a point made by the governor in a speech:
Under the status quo, a wildcatter pays for everything if the
well comes up dry. Under a PPT system where upstream costs are
deductible, in contrast, the state picks up 40 percent of the
dry-hole costs and incurs 40 percent of the dry-hole risk
through deductions, converting losses to credits and marketing
those credits. In a gross system, this is bypassed completely.
He reported that an average exploration well on the North Slope
costs $10 million to $20 million. If the state picks up 40
percent of $20 million, it costs $8 million. Sharing that risk
can make a big difference in whether the well gets drilled,
Mr. Marks said, since it materially affects the exploration
economics. All it takes is to find one field like Alpine -
where a $20 million exploration well found half a billion
barrels, worth $30 billion - for that kind of policy to pay off
enormously for the state. Mr. Marks emphasized that a gross
system would bypass that risk sharing completely.
CHAIR SEEKINS returned to the chart provided by Mr. Marks. He
surmised the differential isn't as great at higher prices.
MR. MARKS agreed.
2:22:51 PM
^Ken Griffin, Deputy Commissioner, DNR
KEN GRIFFIN, Deputy Commissioner, Department of Natural
Resources, offered feedback on issues raised this morning. He
informed members there are a number of NPSLs on the North Slope,
administered by DNR. These are a "net profit royalty" to the
state, and they require an audit process similar to what is
envisioned on the PPT side. Seven of these leases are in
"payout," meaning the operator makes a net profit from them as
defined in regulation; those seven return about $7 million a
month to the state. They are audited by DNR's royalty and
auditing section.
He reported about 95 percent of the value audited, in general,
is closed without dispute. Historically, the state and
producers have successfully resolved the remaining issues. To
his knowledge, Mr. Griffin said, none have been elevated to the
level of the commissioner or have gone to court. There is
concern about setting up PPT rules that will last a long time.
These NPSL rules were set up in 1979 and 1982, are archaic and
don't fit well with how the companies operate today.
Nevertheless, DNR and the companies manage to resolve issues and
come to a common understanding of how to interpret and apply the
rules to meet the needs of the producers and the state.
SENATOR DYSON asked whether statutory authority is needed to
update those rules.
MR. GRIFFIN affirmed that as his personal view. He reiterated
it has been workable and thus isn't urgent. He noted the rules
are written into the leases and thus it is a contractual
relationship rather than a statutory or regulatory one.
2:28:21 PM
MR. GRIFFIN addressed the relationship of royalty reduction to
tax credits. He explained that the purpose of royalty-reduction
regulations, as well as tax-credit provisions in the PPT, is to
change a project's bottom-line economics in order to change
companies' investment behavior. The goal is long-term benefits
to the state by increasing exploration and production, and thus
long-term revenues. The tax credits are designed to shift broad
investment patterns in Alaska. There is a 6 percent decline in
oil, and yet companies invest more than a billion dollars a
year; to arrest this decline and monetize gas reserves, a broad-
based, substantial increase in investment in oil is needed,
perhaps two to three times the current amount, in addition to
gas-related investments including the proposed pipeline.
He contrasted that with royalty relief, a specific, project-
oriented opportunity intended to provide incremental
encouragement to a specific project. Mr. Griffin said the
result of that royalty relief should be that a project becomes
feasible, where without the relief it would not. If relief
won't change the result, it isn't the right answer.
SENATOR WAGONER asked: If the PPT is passed, what will
guarantee that the major producers on the North Slope will use
it to do more exploration? He said ExxonMobil isn't doing any
exploration, for instance.
MR. GRIFFIN replied there are no guarantees, but in his 25 years
of industry experience he has seen significant growth in areas
that have adopted tax regimes such as this. First, if a company
isn't doing exploration and investing, it will have no
deductions and will pay the full tax rate, which is a
substantial increase over what is being paid today. Second,
there isn't sole dependence on these three companies for
exploration; other companies are here or want to be here, and
some are the most aggressive explorers in North America. Third,
the type of tax regime being talked about under PPT has been
used in Norway, England and Alberta to stimulate investment in
some higher-risk, higher-cost projects. He suggested the need
to hear from someone with expertise on those, perhaps Dr. van
Meurs or Mr. Johnston.
SENATOR WAGONER questioned whether Alberta has a production tax.
MR. GRIFFIN clarified that Alberta has a credit system.
SENATOR WAGONER specified it's a 25 percent royalty system, with
only a 1 percent royalty charged until the company recoups its
costs.
MR. GRIFFIN suggested that is something Alaska could do as well.
SENATOR WAGONER said Alaska already has the ability to do that
with its royalty for heavy oil. He indicated it has worked well
for Alberta's tar sands.
CHAIR SEEKINS concluded discussion of SB 3001.
The committee took an at-ease from 2:35:09 PM to 2:50:53 PM.
^Presentation on access to the gas pipeline and basin control
CHAIR SEEKINS informed members there would be a presentation on
access to the gas pipeline and basin control, as requested
during the roundtable discussions.
2:51:28 PM
^Jim Clark, Office of the Governor
JIM CLARK, Chief Negotiator, Office of the Governor, informed
listeners that Mr. Loeffler has been the state's attorney on oil
and gas, particularly FERC matters, since 1974. He said
Mr. Loeffler and Mr. Griffin of DNR are the right people to
address these elements. Thus there would be an extensive
presentation to assure members of what the rules of the road
are, in order to help in assessing the problem.
^Bob Loeffler, Morrison and Foerster, Consultant to the Governor
BOB LOEFFLER, Morrison and Foerster, Consultant to the Governor,
noted when this topic came up the previous week, Chair Seekins
and Senator Ben Stevens had requested that materials be made
available for the record. Accordingly, he was providing:
1) FERC Orders 2005 and 2005-A, regulations governing an open
season for an Alaska gas pipeline; 2) excerpts from the Energy
Policy Act of 2005, which increases penalties under the Natural
Gas Act and other relevant Acts from $5,000 to potentially
$1 million a day; 3) a chapter describing lengthy Order 636,
from a treatise entitled "Energy Law and Transactions";
4) excerpts relating to the federal Minerals Management Service
(MMS) royalty-in-kind (RIK) program and some results showing
improved performance; and 5) Monday's report from FERC to
Congress on progress on the Alaska natural gas pipeline, which
has good projections but warns of threats to this project from
the increasing role of liquefied natural gas (LNG).
2:55:37 PM
MR. LOEFFLER told members he would talk about the framework for
regulation of pipelines and their marketing affiliates; penalty
schemes; special additional requirements that apply to an Alaska
gas pipeline; and two related concepts that have gained some
currency, so-called basin control and basin mastery. Following
that, Mr. Griffin would provide observations gained from his
experience in the industry.
He gave an overview from his handout, "Access to Alaska Gas
Pipeline and 'Basin Control.'" Mr. Loeffler noted an Alaska gas
pipeline will be a tightly regulated, open-access pipeline,
meaning capacity is available to all comers through an open
season auction process. The pipeline sells "transportation
tickets" and by law, since Order 636, gas must be sold as a
separate product; FERC no longer regulates the price of gas, and
has separated gas and the transportation on the pipeline.
He explained that there are restrictions on passing advantageous
information between the pipeline and the marketing affiliate, if
a pipeline has one. Last year, Congress enacted heavy penalties
- up to $1 million a day - in reaction to problems with Enron in
California. Mr. Loeffler said FERC will review competitive
issues when the open season notice comes through; when the
pipeline application comes through after that; and later on. In
addition, FERC has unique powers to mandate expansion of this
pipeline to protect shippers, potential shippers or independents
not affiliated with the pipeline. Mr. Loeffler emphasized that
over its life this pipeline will be the most scrutinized
pipeline in the U.S. and probably Canada.
He provided some history, including that then-President Carter
wanted to ban producers from equity ownership in an Alaska gas
transportation system, and that Congress, by contrast, passed
legislation in 2004 making the application process open to
anyone, including a producer.
2:59:44 PM
MR. LOEFFLER highlighted core features of Order 636 from 1992, a
fundamental restructuring of the U.S. gas pipeline business. He
said pipeline companies provide transportation services and
don't own or sell gas, although they could have marketing
affiliates. Separate companies, some affiliated and some not,
sell gas. Owning a pipeline doesn't give an automatic right to
capacity, or a bidding advantage; the affiliated production
interest must bid in the open season to get capacity to ship
gas. Similarly, owning the gas in the basin connected to the
pipeline doesn't give an automatic right to capacity. Many FERC
requirements for this pipeline are designed so bidders are on
equal footing for the open season. Mr. Loeffler said Order 636
went to the court of appeals and was sustained in all major
aspects; it has been the basis of the modern gas pipeline
industry in the Lower 48 since 1992.
3:03:02 PM
MR. LOEFFLER, in response to Senator Ben Stevens, explained that
widely used in the industry is a "net present value" methodology
that looks at the present value of a bid, including how long
someone is willing to bid, and for how much capacity. The FERC
open season regulations require disclosure of that methodology,
by the pipeline, to all bidders. The pipeline chooses the
methodology, but in the case of this particular pipeline must
put out notice in advance of the open season, with a similar
notice to FERC, that contains 21 kinds of information including,
to his belief, the valuation methodology.
SENATOR BEN STEVENS requested clarification about the meaning of
"bid" in this instance.
MR. LOEFFLER suggested thinking of a train, acknowledging it's a
bit simplified. He said it's how many seats on the train one
wants to buy, for how long. Each unit of gas is akin to a seat.
In the open season notice, the pipeline also puts out its
estimate of the tariff, the cost of the seat. Then an entity
bids for how many seats it will buy, for how many years. In
further response, he said the pipeline proposes a price
consistent with FERC rate making. If the pipeline doesn't come
through at this estimated price, then the deal is off and
shippers usually can get out of the contract.
3:08:02 PM
MR. LOEFFLER returned to his overview. With respect to the
application for this certificate to build the pipeline, he said
FERC reviews it to a fare-thee-well. An application is volumes,
going into engineering design; permitting; size, including
expandability; and proposed tariff rates. One cannot add
compressor stations or even go out of the natural gas pipeline
business without permission from FERC. Typically, this isn't
true of an oil pipeline. Under its regulations for this gas
pipeline, FERC will look at how the project design considers the
capacity needs of future shippers as well as the first shippers.
When the open season ends, if successful, there will be bidding
for capacity. If some bidders are a bit late but have a good
reason, FERC has said it will make the pipeline show why that
cannot be accommodated.
He characterized the open season process as the first public
step, groundwork preceding an application to FERC. The pipeline
tests the market, ensuring there are enough shippers that want
to ship gas. Mr. Loeffler said those commitments are like
leases for anchor tenants in a shopping center that can be taken
to the bank to permit financing.
He reported that FERC's expectation is that an Alaska gas-
transportation project will be designed and built, to the extent
possible, to accommodate all qualified shippers ready to sign
these firm transportation (FT) agreements, since this will be
the only pipeline for many years to bring gas from the North
Slope. Mr. Loeffler noted that bidding methodology in the
Lower 48 usually includes tie-breaking methodology; net present
value is one way of deciding that.
3:12:42 PM
MR. LOEFFLER gave some history and then explained that the
Alaska Natural Gas Pipeline Act (ANGPA) of 2004 is a special set
of provisions removing some bureaucratic hurdles and ensuring
competitive access. It also provides regulations for an open
season; such regulations don't exist in the Lower 48, although
there is a lot of case law. For this pipeline, Congress wanted
regulations that control access to the pipeline, and a level
playing field for potential shippers.
He continued, saying the Energy Policy Act of 2005 vastly
strengthened the penalties. It also created a new section 4(a)
of the Natural Gas Act, which prohibits market manipulation,
covering not only jurisdictional entities, but also related
activities. It makes it unlawful for any entity, directly or
indirectly, to use in connection with the purchase or sale of
natural gas - or the purchase or sale of related transportation
services subject to FERC jurisdiction - any manipulative or
deceptive device or contrivance. Mr. Loeffler referenced the
SEC Act and said the commission has implemented this with a
definition of fraud that he'd show members later.
3:15:02 PM
MR. LOEFFLER discussed FERC orders. He informed members that
the only FERC orders specific to Alaska are Orders 2005 and
2005-A; the others apply to all interstate pipelines. He
characterized FERC as the "cop on the beat" at the various
stages: 1) the open season notice, 2) the application to FERC
resulting in a certificate, 3) pipeline construction and
4) pipeline operations. A FERC certificate typically has pages
of construction conditions, and a notice-to-proceed process will
be done with other federal agencies. Typical in the Lower 48 is
that a deadline is established by which the pipeline must be
built after the certificate is accepted.
He noted Order 436 was the predecessor to Order 636, which
required that any transportation offered must be
nondiscriminatory. Pipeline customers that used to buy bundled
service thus could contract directly with producers; this was to
encourage competition. Mr. Loeffler referred to the Alberta Hub
and said the whole idea of trading natural gas evolved from the
separation of transportation and gas markets; that was what FERC
wanted, and people quickly set up affiliates. With respect to
independent pipelines, he pointed out that many have marketing
affiliates that sell gas.
He skipped over capacity release, turning to Order 637, which
put in more stringent standards on proper conduct and
scheduling, for instance, separating it into fine gradations of
service. Mr. Loeffler said Order 2004 filled in the content of
the standards of conduct; the idea was to not give preferential
treatment to the affiliated gas marketer. Some were expressly
adopted in Order 2005, but apply regardless; he gave details.
Before the most recent statute, he noted, FERC could order
discouragement of unjust profits and could revoke various
authorities including the basic certificate of public
convenience and necessity.
He reported that the penalty or forfeiture provisions, however,
were trivial and lacked teeth. In 2005, Mr. Loeffler said,
penalties increased to $1 million a day for civil penalties and
the same for criminal penalties, in addition to possible prison
time of five years.
3:20:06 PM
MR. LOEFFLER elaborated, pointing out that anyone who improperly
manipulated transportation rights or contrived to manipulate gas
sales could face huge penalties and a lot of time in jail. He
said FERC would look at how the markets were harmed, what the
harm was, whether the company did anything to cure it, whether
it was fraudulent and whether it was a repeat offense. He
highlighted improvement at FERC following what happened in
California, noting FERC has become strict in enforcing even some
of its simplest rules, a real change from Chairman Wood to the
current chairman.
He said Order 670, the latest one, implements new 4(a), on
energy market manipulation, which applies if something is even
connected with a jurisdictional transaction and makes it
unlawful to: defraud using a device, scheme or artifice; make
any untrue statement of material fact or omit a material fact;
or operate or engage in any act, practice or course of business
that operates as a fraud or deceit. Mr. Loeffler also
emphasized the breadth of the definition of fraud: any action,
transaction or conspiracy for the purpose of impairing,
obstructing or defeating the honest functioning of the market.
He turned to special regulations for an Alaska gas pipeline,
summarized in Part IV of his handout. Mr. Loeffler said the
orders themselves exceed 100 pages and are specific. For
enforcing penalties, the more specific the regulation is, the
easier it is to show whether a violation occurred. He indicated
FERC wanted to: provide certainty for this pipeline; promote
competition and prevent unduly discriminatory behavior; and
prevent a project applicant from unduly favoring its affiliate.
With respect to the words "undue" and "unjust," he reported that
the federal statutes use those terms, as well as "unreasonable."
He explained that the pipeline must construct an open season
notice that complies with the 21 requirements. To put everyone
on equal footing, this is given to bidders in advance so they
can prepare by running economic models and so forth. Then FERC
will review that, in advance of the open season, to ensure its
regulations are complied with. Mr. Loeffler noted FERC reserves
the right to reject the certificate application.
3:25:56 PM
MR. LOEFFLER advised members that in the open season, by law,
information must be provided about in-state bidding and tariffs,
because interested parties must be ready to bid when the open
season notice goes out. He cited 18 C.F.R. 157.34 as an
important catch-all that says all information regarding the
proposed service to be offered - including pipeline capacity,
the proposed tariff, design and cost projections - must be
available to, or in the hands of, any potential shipper prior to
public notice of an open season; this is to provide equal
footing. For the same reason, affiliated marketing units must
be identified and are prohibited from obtaining nonpublic
information. The open season during which parties can bid is
open at least 90 days by regulation. Usually there is a fine-
tuning period for the bids.
He referred to undue preference and discrimination, saying
general requirements under 18 C.F.R. 157.35 include that there
shall be no preference in rates, terms, conditions of service or
allocation of capacity, and that the commission shall use its
fast-track procedures to resolve any complaint. In addition,
(c) provides that those connected with the pipeline who conduct
the open season must function independent of any other division
of the project applicant. Mr. Loeffler alluded to information
in his handout relating to subsections (d) through (g) of
18 C.F.R. 157.35.
3:29:30 PM
MR. LOEFFLER turned to basin control, the idea that those with
warehouse capacity would sign up for more "tickets" than they
need, for a longer time than needed, thus excluding
independents. Although there might be a business reason, it
might be done to lock out a competitor. He said FERC will look
for that and be suspicious if someone takes capacity for a long
time while having no more resource to ship. He noted FERC has
suggested it wouldn't be in the shipper's economic interest to
bid for capacity beyond the projected life of its reserves.
He expressed confidence that there is a big tool kit to respond
to this concern. For example, FERC can force separation of the
marketing affiliate from the pipeline affiliate and from the
entity that conducts the open season. In addition to the
special requirements for this gas pipeline he'd discussed,
Mr. Loeffler indicated FERC has said it will review anti-
competitive behavior - both in a letter from former Chairman
Wood in response to a query from the Alaska State Legislature
and "because it will do it naturally" - and will be on the
lookout for unusual occurrences.
He emphasized that FERC has the power to order expansion of this
pipeline - which isn't true for any pipeline in the Lower 48 -
if someone is excluded down the road, at a time when there is
more gas to ship than there is capacity. Showing a slide
labeled "Daniel Johnston Testimony on SB 305 and HB 488,
April 9, 2006," Mr. Loeffler recalled Mr. Johnston's use of the
term "basin master" in the context of projects around the world
where there are cozy relationships between governments and
project developers, for instance. Mr. Loeffler recapped points
from Mr. Johnston's testimony, emphasizing that whereas
Mr. Johnston had said early infrastructure corridors often are
overbuilt, the concern for this current project has been the
opposite, that it won't have enough capacity.
He quickly addressed the appendix to his presentation, showing
open season notice requirements in 18 C.F.R. 157.34.
Mr. Loeffler explained that those are so detailed because the
state, the legislature and the shippers wanted to know there was
a fair playing field. He drew attention to item (15),
specifying to Senator Ben Stevens that one requirement is
disclosure of the methodology by which capacity will be awarded.
Mr. Loeffler turned the presentation over to Ken Griffin, deputy
commissioner of DNR.
3:35:16 PM
^Ken Griffin, Deputy Commissioner, DNR
MR. GRIFFIN said he didn't have much to add, but emphasized his
belief that explorer access has been dealt with effectively
through this. Equal opportunity on the North Slope is
maintained, largely through DNR's leasing program; that is
unchanged by the proposed fiscal contract. In addition, primary
lease terms, royalties and so forth remain under DNR's purview.
The uniform upstream fiscal contract, proposed through separate
legislation in the past session, provides "equal footing to the
economic benefits of exploration," Mr. Griffin said, agreeing
with Mr. Loeffler that FERC rules provide equal access to the
infrastructure system through the open season process and FERC's
unique expansion authority. He turned the presentation back to
Mr. Loeffler.
MR. LOEFFLER recalled that FERC's open season rules say, in
essence, that in any expansion it will look to be sure that
shippers other than for Point Thomson and Prudhoe Bay have
capacity available to them. He characterized it as another
check, since FERC will look at who has the gas today and who
might have it in the future.
3:37:23 PM
SENATOR BEN STEVENS referred to the open season notice
requirements in 18 C.F.R. 157.34 in the appendix to
Mr. Loeffler's presentation. He called attention to item (15),
which read:
(15) The methodology by which capacity will be
awarded, in the case of over-subscription, clearly
stating all terms that will be considered, including
price and contract term. If capacity is oversubscribed
and the prospective applicant does not redesign the
project to accommodate all capacity requests, only
capacity that has been acquired through pre-
subscription or was bid in the open season on the same
rates, terms, and conditions as any of the pre-
subscription agreements shall be subject to allocation
on a pro rata basis; no capacity acquired through the
open season shall be allocated;
He asked whether "applicant" in the second sentence of item (15)
would be the state and the producer group.
MR. LOEFFLER affirmed that, specifying it would be the pipeline
LLC.
SENATOR BEN STEVENS requested a definition of "pre-
subscription."
MR. LOEFFLER replied there was a lot of comment about whether
"anchor shipper" agreements should be permitted on this
pipeline. The commission struck a balance. An anchor shipper
is someone willing to sign up before the open season, and there
are special requirements. The competitive concern was that
large North Slope producer marketing affiliates would strike
deals with the pipeline prior to an open season. Mr. Loeffler
indicated "pre-subscription" refers to those anchor shippers.
SENATOR BEN STEVENS interpreted the language following "pre-
subscription" in item (15) to mean that any pre-subscription or
open season subscription is treated the same way.
3:40:29 PM
MR. LOEFFLER answered by highlighting the clause "no capacity
acquired through the open season shall be allocated". He
explained that while FERC has said it would permit these
controversial pre-subscriptions, the terms must be disclosed
within 10 days of execution, and other shippers can piggyback
and get the same terms. Thus someone could either bid
independently in the open season or acquire those same terms on
a pro-rata basis if there were a shortage of capacity.
SENATOR BEN STEVENS asked: If there is over-subscription, are
all subscriptions, whether pre-subscription or post-
subscription, treated the same?
MR. LOEFFLER said the set isn't 100 percent. While it is true
that pre-subscribers can get less capacity, as is true for
anyone who piggybacks, there is a third class of people who
didn't piggyback and aren't "cut down."
CHAIR SEEKINS surmised that someone who bids in the open season
and thereby causes over-subscription isn't subject to proration.
MR. LOEFFLER affirmed that.
SENATOR BEN STEVENS asked: If an independent company waits
until the open season and puts in a bid that causes over-
subscription, that later bid isn't prorated, whereas the
previous bid is?
MR. LOEFFLER affirmed that as the design. He said the idea is
that prior bids are potentially anti-competitive and hence
should be subject to proration.
3:42:51 PM
SENATOR BEN STEVENS suggested the later someone comes into the
bidding process, then, the better. A person would know the
rates and that there wouldn't be proration.
MR. LOEFFLER responded that someone wouldn't know whether there
would be over-subscription. Noting there was a qualification
that he would put aside, he explained that if there are a lot of
roughly equal bids, too many for the available capacity, the
pre-subscribers are the ones subject to being reduced. He noted
there had been an argument that pre-subscribers are entitled to
equal or better treatment because of being the first to sign up;
the argument against that, however, was that those would be the
North Slope producers, who would have more information and
shouldn't receive an advantage. Then FERC said it wouldn't
prohibit pre-subscriptions, but would require disclosure within
10 days of execution, and in case of a shortage those would be
the ones reduced.
He said there is another catch in the clause, if the prospective
applicant doesn't redesign the project to accommodate all.
Mr. Loeffler added that he believes the pressure from FERC would
be to ensure it could be large enough to accommodate everyone so
the "cut down" situation isn't reached.
3:45:14 PM
SENATOR BEN STEVENS voiced his understanding, then, that the
intent is to build the project to meet capacity, but if that
doesn't happen, it will be addressed such that those who make
the commitment first will be prorated, as opposed to those who
make a commitment at the same rates later on, with the caveat
that it won't be known whether there is over-subscription.
MR. LOEFFLER indicated there was a technical point he'd have to
work on, relating to whether the bids would be exactly the same.
SENATOR BEN STEVENS requested a written answer from Mr. Harper
and Econ One to the following: Given (15), how can anybody
exercise basin control?
MR. LOEFFLER replied by reading the last sentence of his
slide 5, a quotation from FERC Order 2005-A: "Our expectation
is that an Alaska gas transportation project will be designed
and built, to the extent possible, to accommodate all qualified
shippers who are ready to sign firm transportation agreements."
He remarked, "Hopefully, you don't get to the prorationing
step."
SENATOR BEN STEVENS restated his request: If Mr. Harper is
hired to say how to manage basin control, perhaps he could
outline something to be taken to FERC so that FERC could
implement the changes on basin control, since FERC - and not the
Alaska State Legislature - obviously controls the basin and the
regulations surrounding access to the pipeline.
CHAIR SEEKINS suggested that be looked at. He noted one
question has been where FERC control begins and thus where the
equal-access point begins.
SENATOR BEN STEVENS also asked what level of authority the state
has in basin control related to this project.
CHAIR SEEKINS opined that the state has no authority, but said
it could be looked at. Elaborating on the open question of
where FERC control comes into play - whether for the gathering
system or upstream or downstream from the gas-treatment plant -
he indicated that if entities conspired to block out a
competitor at the pre-subscription point, for example, he
believed they would be the ones to pay the price.
3:49:29 PM
MR. LOEFFLER, with respect to where FERC jurisdiction begins,
clarified that all the open season orders deal with
jurisdictional facilities. When Congress amended the Natural
Gas Act, adding 4(a) in the Energy Policy Act of 2005, it
created a new tool in the toolbox. The order bars energy market
manipulation by any entity, not just jurisdictional entities, if
it's in connection with a jurisdictional transaction and if
there is contrivance, manipulation or fraud.
SENATOR HOFFMAN asked if a producer can participate in both the
pre-subscription and the open season.
MR. LOEFFLER replied yes.
SENATOR HOFFMAN asked whether someone could participate more
than once in either one, submitting separate proposals.
MR. LOEFFLER answered, "In some sense, yes." He said he was
struggling with how it would operate. He surmised there could
be a pre-subscription agreement for some part of the capacity,
and then a bid with a different term, a longer time, for
example. Mr. Loeffler recalled a practice in some Lower 48 open
seasons of getting local farmers to submit artificial bids,
which Enron did, but said he believed the 2005 statute would
prohibit that.
3:52:38 PM
REPRESENTATIVE RALPH SAMUELS, Alaska State Legislature, asked
whether BP, for example, could come in with a low bid as an
anchor shipper and then a high bid in the open season that
couldn't be prorated. He asked why someone would want to be an
anchor shipper at all. If the price was unknown and there was
the possibility of proration, why not just wait?
MR. LOEFFLER noted this gets into bidding theory and indicated
he'd have someone else answer. He added that in the pre-
regulation world, anchor shippers helped to get pipelines built;
thus they got a preference. Because agreements must be
disclosed and so forth, however, he wasn't sure why someone
would want to be a pre-subscriber in this pipeline.
CHAIR SEEKINS said he didn't know their bidding strategy either,
but would be nervous about it.
3:54:28 PM
SENATOR GENE THERRIAULT, Alaska State Legislature, recalled that
the state, federal agencies, independents and the legislature
had submitted comments to FERC during its development of this
package. While he was satisfied with the results, the producers
initiated litigation to get FERC to back off on issues they
believed problematic; that was deemed untimely and was
dismissed, and the producers came back after paring it down to
one issue.
He explained that a concern of his, and of the independents in
Alaska, is how the contractual language may limit full
application of the FERC rules detailed here. Senator Therriault
indicated the independents' success, through robust exploration
and unfettered access to the means to ship gas to market, would
be good for the state. Noting he'd asked Mr. Harper and
Mr. Shepler to attend today, he agreed with Senator Ben Stevens
that it would be good to have something submitted in writing.
3:57:30 PM
MR. CLARK, with regard to the contract, reported there was a
recent full-day discussion at the Resource Development Council
(RDC) that representatives from Anadarko and Tesoro attended.
Two issues raised are relevant to Senator Therriault's concern.
One involves Article 8.7, state-sponsored access for expansion,
which provides opportunity for both voluntary expansion -
covered in FERC regulations - and mandatory expansion, unique to
the Alaska situation. Anadarko had concerns about the state-
sponsored opportunity, while recognizing the intent to provide a
third means of access pursuant to dispute resolution provisions
of the contract. In that forum, and in other forums attended by
Anadarko, Mr. Clark said no other issues were raised by Anadarko
regarding this issue.
He explained that, second, Tesoro was concerned about
availability of access prior to the open season. Mr. Clark
noted the state said several things in terms of policies to be
developed, which can be found in the fiscal interest finding;
these aren't in the contract because how the state uses its gas,
taken in kind, is up to the state and not the producers. He
indicated the state, as it develops its policies, intends to
make state gas available for in-state use, which is the in-state
portion Tesoro is concerned about; it also intends to assist
anyone wanting to bid in that first open season in understanding
the rules if there is in-state usage for which there is a
separate open season under FERC.
He specified that the aforementioned concerns are the two the
state has heard up to this point. Mr. Clark concluded by
saying, "We are aggressively addressing those concerns, and will
address any others that come up as we get to the end of the
public comment period."
SENATOR THERRIAULT opined that Mr. Harper would bring a good
perspective to the discussion, as former head of a pipeline
operation, and could speak to how a company can use its
influence, for example.
4:01:46 PM
SENATOR BEN STEVENS returned to earlier discussion and asked
Mr. Loeffler: Do the rates submitted by the pipeline in a pre-
subscription period have to be approved by FERC? And if FERC
does an analysis of the applied-for rate and says it isn't
adequately developed, can it say to go back and change it?
MR. LOEFFLER replied it's more complicated than that. The open
season rates that are offered are subject to a lot of
conditions, and the rates proposed with the application ought to
be consistent with the successful bids in the open season. He
said FERC really reviews the rates in the application, although
it has the power, to his belief, under the open season
regulations, to look at the proposed rates that are put in the
open season notice. He added that this was untested ground,
from his experience, and he wasn't sure.
SENATOR BEN STEVENS clarified his point: The applied-for rates
must be approved by FERC. They must be legitimate and detailed,
and must meet criteria on how the rates are determined.
MR. LOEFFLER affirmed that, but explained that when FERC grants
an application for a new pipeline usually there is a settlement
with FERC staff that requires the pipeline to come in with a
rate case within three years. The Section 7 rates that are
approved are "public interest" rates, rather than the "just and
reasonable" rates under Section 4 or 5. As general law, FERC
approves the project, grants the certificate and approves the
rates initially, but the pipeline must come back with the rate
case - that is the usual compromise, he said - within three
years of the startup of operations, to see how experience has
affected those rates.
CHAIR SEEKINS surmised FERC looks to see whether those rates are
in the best public interest.
MR. LOEFFLER answered that it starts out "in the public
interest," but "just and reasonable" is a higher standard.
There is a lot of scrutiny.
CHAIR SEEKINS invited Donald Shepler and Rick Harper to the
witness table.
4:05:57 PM
^Donald Shepler, Greenberg Traurig, Consultant to the
Legislature
DONALD SHEPLER, Greenberg Traurig, LLP, Consultant to the
Legislature, explained that he is an attorney from Washington,
D.C., who represented the Legislative Budget and Audit Committee
in the FERC proceedings that gave rise to the regulations being
discussed today. Speaking in favor of addressing expansion
issues in the contract, he told members that, with all due
respect to Mr. Loeffler, he believed the problem to be further
down the road than suggested.
He proposed thinking of basin control as exercising control over
this essential pipeline facility so as to disadvantage
competitors in producing natural gas on the North Slope; this
could include trying to drive competitors out of the business or
acquiring a competitor's leases over time. After a pipeline is
built, the risk is that owners will engage in practices which
make it difficult to obtain access, or will delay or refuse to
engage in expansion; thus in later years producers would have no
place to take their production.
He asked to put this in writing at a later date, as requested by
Senator Ben Stevens and seconded by Senator Therriault, but
offered an oral summary. Mr. Shepler agreed that in the 1970s
there was a prohibition of producer ownership of any interest in
the pipeline; this was waived in the 1980s, but with the
condition that there be no risk of basin control by any
producer-owners with a stake in the pipeline. That was under
the guise of the 1977 statute.
He said now, in addition to the 2004 statute, there is FERC's
reaction to the January 2005 letter from Representative Ethan
Berkowitz to the chairman, asking about the status of the 25-
year-old prohibition and waiver; the chairman had responded that
this will be addressed by FERC when it issues its orders in this
proceeding. Mr. Shepler made the point that the issue of basin
control, in one form or another, goes back 30 years.
He agreed FERC extensively regulates the gas-pipeline business,
as summarized by Mr. Loeffler, and has regulations specific to
the Alaska pipeline. Mr. Shepler pointed out, however, that
FERC is far away; its proceedings are expensive and time-
consuming; and the final outcome is always uncertain.
Therefore, he suggested the simpler fix to the risk of basin
control is to address it in the contract now under negotiation.
He proposed that the state negotiate firm, binding commitments
with the producers that voluntary expansions will occur in
commercially reasonable circumstances, in "engineeringly
reasonable increments of capacity," with rates that accommodate
the FERC presumption of rolled-in pricing. Thus Mr. Shepler
said future explorers, in later years, would know they could
gain access to the pipeline under reasonable terms, with
reasonable, nondiscriminatory rates that don't put 100 percent
of the burden of expanding the pipeline - once it gets to be an
expensive expansion - on newcomers.
He suggested dealing with this in the negotiation phase would
put the state in the best position. It could take control of
its own destiny, rather than relying on the vagaries of
expensive and lengthy FERC proceedings where the outcome is
uncertain. Although FERC is a powerful agency with extensive
tools and regulations, Mr. Shepler pointed out that such a
contractual provision could ensure expansion under reasonable
terms through the life of the pipeline, and FERC regulations
would exist as backup. He reiterated his desire to flesh this
out in writing.
4:14:05 PM
SENATOR BEN STEVENS suggested "future access" is perhaps a
better term than "basin control" for the issue. He requested
that Mr. Shepler's written comments include that the designed
pipe would have cheap expansion built in. He said proven gas is
only two-thirds of what is needed at 4.2 billion cubic feet
(Bcf) a day, at this point. He asked to see justification for
concern about future expansion above 6.0 Bcf, since there is
about a 40 percent expansion capacity already. He opined that
this allows for "exploration capacity" as well.
He expressed appreciation for the deliberations behind FERC
decisions and their longevity, but pointed out FERC was given
direction by Congress in 2004, came up with two major decisions
and is about ready to make a third and has submitted two reports
to Congress on the Alaska natural gas pipeline. Yet legislators
are still struggling through their own first decision. Senator
Ben Stevens commented, "We may be the more expensive and the
more uncertain body in determination of what's the outcome of
this process, versus the FERC."
4:18:04 PM
MR. SHEPLER responded to Senator Ben Stevens' first comment. He
said during last week's conversation he was pleased to hear the
project characterized as a 5.9 Bcf pipeline, starting at 4.2 but
anticipated to expand to 5.9 or 6.0. He related his first
reaction: If that's the intention of all the parties, then the
adage "trust but verify" from former President Reagan suggests
putting it in the contract.
He also pointed out differences between deliverability and
reserves. Mr. Shepler explained that the level of
deliverability - how much gas can come out of the ground on a
given day - is used to size a pipeline, but reserves are relied
upon for a pipeline's longevity. The problem now is reserves.
Deliverability, however, is an issue down the road as new gas
wells are drilled, perhaps adding to the reserves, but adding to
the gas available to flow on a day-to-day basis.
He said the expansion issue doesn't need to wait for an extra
15 trillion cubic feet (Tcf) to be discovered; it can appear
now, with the next well drilled. Mr. Shepler also said
expandability - up to 6.0 Bcf and beyond, to the maximum
capability of the pipeline - is in the long-term interest of the
state, a crown jewel the state should capture to guarantee that
those expansions take place. He opined that the state is
probably better off fixing the problem now, in the contract,
rather than relying on either the lengthy Article 8.7 process or
FERC's regulatory process.
^Rick Harper, Econ One Research, Inc., Consultant to the
Legislature
RICK HARPER, Econ One Research, Inc., Consultant to the
Legislature, agreed with Mr. Shepler and told members his own
comments would preface testimony anticipated from the
independents, the real voice in this issue, whom he'd talked
with but wouldn't speak for.
4:22:39 PM
MR. HARPER concurred with Mr. Loeffler's testimony today
relating to FERC, particularly commending the job he'd done of
addressing concerns relating to marketing affiliates and so
forth. Mr. Harper pointed out that natural gas pipelines are
contract carriers, for-profit enterprises that are granted a
great deal of latitude in the operation of their businesses
through FERC and state regulation. They pursue self-interests
with great vigor, although there are checks and balances.
He said the business model emerging here is different from what
is seen elsewhere in North America; he has no quarrel with that,
but it raises issues and concerns. Mr. Harper explained that
pipelines must construct tariffs, rate structures and expansion
policies on a case-by-case basis. Noting there is a reason
companies want to own pipelines, he provided an analogy of being
a member of an important committee or chairing such a committee,
which gives standing and a seat at the table.
He said FERC is an extremely effective body, with a rich
history. But this current situation hasn't been seen before, at
least not for a long time. Producers want to own a pipeline as
well as subscribe to the capacity. Because they have discrete
geographic positions at this time, and because others eventually
will be involved and will have different positions, Mr. Harper
suggested the need to be careful. While agreeing with
Mr. Shepler to a great extent, Mr. Harper surmised much of their
concern probably arose because the contract itself is silent in
a number of key areas.
He highlighted crucial elements that should be known from the
start: the size of the pipeline; how much compression will be
in place from the beginning; how expansions will occur, on a
voluntary basis and otherwise; and that there will be an
expansion-friendly system. Mr. Harper observed that nothing
precludes a change in the configuration of this system. Thus it
is important to know these elements from the beginning, to know
initial expansions will be inexpensive and friendly to those who
don't currently have a seat at the table. He listed unknown
factors: the tariff, which he said could be known; the capital
structure; and the debt-equity ratio, which will have a
significant impact on the tariff.
He explained that normally an independent pipeline company
without any interest in the production doesn't have a position
in consumption like ownership of power generation, and doesn't
have an extensive marketing affiliate; one can presume the
interests align in a certain way. However, Mr. Harper said, he
doesn't come to that same conclusion about large producers such
as ExxonMobil and BP. They aren't precluded from owning this
pipeline, which he believes is fine. Nonetheless, their
interests are different from, and broader than, those of
independent pipeline companies.
4:28:21 PM
MR. HARPER continued, saying one would presume it would be in
their interest to have a high tariff, but they might not seek
that. This agreement has gaps and doesn't reveal the tariff
structure or the terms of participation in firm capacity, at
least as recommended to FERC. He suggested those should be
included or, if not, there should be an understanding that the
risk exists for the state, and that the disadvantaged ones will
be future explorers and developers.
He noted there is a reason why a producer wants to be an
operator in a field, getting back to his earlier analogy, and
why a particular pipeline owner might want to operate the
pipeline. There are distinct advantages. While that's okay,
Mr. Harper recommended erring on the side of caution, putting
the "belt and suspenders" in the agreement in those key areas of
tariffs and expansion.
He explained that relying on FERC processes can be time-
consuming and cumbersome. Characterizing time as both a friend
and a weapon, Mr. Harper pointed out there could be a company
that discovers a new field and has 3 Tcf of gas. If there is
requirement to sign up for 30 years for firm capacity, or to
agree to terms that don't fit that company's business regimen -
and if the company running the pipeline isn't amenable to
changes - then there are remedies, yes, but they are expensive
and time-consuming. Thus he indicated it would be advantageous
to fill the voids in the agreement now, as mentioned by
Mr. Shepler, to the extent reasonable. Mr. Harper requested the
right to submit a written document to add to his comments.
SENATOR THERRIAULT suggested that as a past chief executive
officer of a pipeline company, Mr. Harper could provide a
glimpse into how things really operate, with concrete examples.
He noted there is a spirited debate going on now about who will
be the operator, a position that carries advantages.
4:32:31 PM
CHAIR SEEKINS observed that the government process is slow and
cumbersome compared with rapid decisions possible in a small
business. He offered his experience that all parties in a
business relationship, even the independent companies in this
situation, are motivated by self-interest, although they must
operate within the boundaries of the regulatory process. He
opined that the pipeline is fairly low-risk, whereas getting the
gas to market carries higher risk; he surmised that balancing
those is one motivation. Chair Seekins also said he understands
the forces in the business process, but there is a boundary of
reasonableness and regulation, which is where he sometimes has a
problem.
He announced he would ask someone from FERC to speak to the
committee on this issue, though not because he was discounting
the testimony from the FERC attorneys. Chair Seekins
acknowledged the varying interests of the producers and
independents, saying that is business - not bad, but sometimes
tough. He highlighted the state's need to ensure that whoever
finds gas has a way to get it to market so the state can tax it
and get its royalty, but without somehow degrading the value of
the gas before it is taxed. Chair Seekins concluded by
emphasizing the need to balance these interests, expressing hope
that this is what the administration is trying to do with the
contract as well.
MR. CLARK responded, "We are trying to balance these things up."
He said it would be helpful when the written comments come in to
have more specificity. With regard to looking at Article 8.7,
he indicated the administration is doing that. He also noted
Anadarko has raised the issue of how to get ready for the first
open season, and that the administration's response is that it
will provide some help.
4:38:18 PM
MR. CLARK continued, saying he'd also heard today that there
should be a "tariff target" in the documents, and a bit more on
debt-equity structure. In addition, rolled-in rates should be
covered, up to the amount of the expansion. He noted he was
listing the administration's items for discussion with the
producers. He said it would be helpful if that list could be
expanded beyond the more general topics, because the
administration is trying to find ways to address access,
expansion and other highly important issues for the state.
CHAIR SEEKINS remarked that he doesn't think it is wrong to ask
the state to try to intervene in some of those relationships;
otherwise, he himself wouldn't have been before the legislature
previously asking for franchise laws to be passed to help
protect him from one of the largest corporations in the world.
MR. CLARK said that was the purpose of Article 8.7 in the
contract. He indicated the administration had asked Anadarko
how that might be changed, and he said there are a number of
requirements in that article, which is designed to provide a
contractual way to speed the process before FERC; it deals with
some of the issues raised by Mr. Shepler and Mr. Harper.
4:39:48 PM
CHAIR SEEKINS expressed hope that Anadarko would be ready to
testify soon on these matters.
MR. LOEFFLER added to Mr. Clark's comments, saying a number of
issues such as voluntary expansion and a "capital structure
target" are addressed in the LLC, which admittedly Mr. Shepler
and Mr. Harper hadn't seen. He said more is coming.
CHAIR SEEKINS expressed appreciation to the participants and
indicated SB 3002 would be discussed specifically tomorrow. He
closed the hearing, with both SB 3001 and SB 3002 held over.
There being no further business to come before the committee,
Chair Seekins adjourned the Senate Special Committee on Natural
Gas Development meeting at 4:42:35 PM.
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