Legislature(2005 - 2006)BUTROVICH 205
02/27/2006 03:30 PM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| SB305 | |
| Conocophillips, Brian Wenzel, Finance and Administration | |
| Conocophillips, Marianne Kah, Chief Economist | |
| Wenzel - Question and Answer | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 305 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
February 27, 2006
3:49 p.m.
MEMBERS PRESENT
Senator Thomas Wagoner, Chair
Senator Ralph Seekins, Vice Chair
Senator Ben Stevens
Senator Fred Dyson
Senator Kim Elton
Senator Albert Kookesh
MEMBERS ABSENT
Senator Bert Stedman
OTHER MEMBERS PRESENT
Senator Gretchen Guess
Senator Gene Therriault
Senator Hollis French
COMMITTEE CALENDAR
SENATE BILL NO. 305
"An Act repealing the oil production tax and gas production tax
and providing for a production tax on the net value of oil and
gas; relating to the relationship of the production tax to other
taxes; relating to the dates tax payments and surcharges are due
under AS 43.55; relating to interest on overpayments under AS
43.55; relating to the treatment of oil and gas production tax
in a producer's settlement with the royalty owner; relating to
flared gas, and to oil and gas used in the operation of a lease
or property, under AS 43.55; relating to the prevailing value of
oil or gas under AS 43.55; providing for tax credits against the
tax due under AS 43.55 for certain expenditures, losses, and
surcharges; relating to statements or other information required
to be filed with or furnished to the Department of Revenue, and
relating to the penalty for failure to file certain reports,
under AS 43.55; relating to the powers of the Department of
Revenue, and to the disclosure of certain information required
to be furnished to the Department of Revenue, under AS 43.55;
relating to criminal penalties for violating conditions
governing access to and use of confidential information relating
to the oil and gas production tax; relating to the deposit of
money collected by the Department of Revenue under AS 43.55;
relating to the calculation of the gross value at the point of
production of oil or gas; relating to the determination of the
net value of taxable oil and gas for purposes of a production
tax on the net value of oil and gas; relating to the definitions
of 'gas,' 'oil,' and certain other terms for purposes of AS
43.55; making conforming amendments; and providing for an
effective date."
HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: SB 305
SHORT TITLE: OIL AND GAS PRODUCTION TAX
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR
02/21/06 (S) READ THE FIRST TIME - REFERRALS
02/21/06 (S) RES, FIN
02/22/06 (S) RES AT 3:30 PM BUTROVICH 205
02/22/06 (S) Heard & Held
02/22/06 (S) MINUTE(RES)
02/23/06 (S) RES AT 3:30 PM BUTROVICH 205
02/23/06 (S) Heard & Held
02/23/06 (S) MINUTE(RES)
02/24/06 (S) RES AT 3:30 PM BUTROVICH 205
02/24/06 (S) Heard & Held
02/24/06 (S) MINUTE(RES)
02/25/06 (S) RES AT 9:00 AM BUTROVICH 205
02/25/06 (S) -- Reconvene from 02/24/06 --
02/25/06 (H) RES AT 10:00 AM SENATE FINANCE 532
02/25/06 (S) Heard & Held
02/25/06 (S) MINUTE(RES)
02/27/06 (S) RES AT 3:30 PM BUTROVICH 205
WITNESS REGISTER
BRIAN WENZEL, Vice President
Finance and Administration
ConocoPhillips Alaska
POSITION STATEMENT: Presented company position on SB 305.
MARIANNE KAH, Chief Economist
ConocoPhillips Alaska
POSITION STATEMENT: Presented company position on SB 305.
DARREN JONES, Vice President
Commercial Assets
ConocoPhillips Alaska
POSITION STATEMENT: Presented company position on SB 305.
ACTION NARRATIVE
CHAIR THOMAS WAGONER called the Senate Resources Standing
Committee meeting to order at 3:49:06 PM. Present were Senators
Kookesh, Elton, Dyson, Seekins, Ben Stevens and Chair Thomas
Wagoner.
SB 305-OIL AND GAS PRODUCTION TAX
3:49:06 PM
CHAIR WAGONER announced SB 305 to be up for consideration and
that the committee would hear stakeholder presentations.
^ConocoPhillips, Brian Wenzel, Finance and Administration
BRIAN WENZEL, Vice President, Finance and Administration,
ConocoPhillips Alaska, said ConocoPhillips has been working in
Alaska for 45 years and it is the state's leading oil producer,
its leading explorer and its leading champion for the gas
pipeline. It also has been the leading investor in Alaska and
this year, alone, is reinvesting over $700 million in Alaska
capital projects on core legacy fields and new development. Over
the past 10 years it has invested over $5.8 billion in capital
and another $6.8 billion in expenses in this state. It is among
the state's largest employer of Alaskans and it pays more than
any other entity, a total of $1.6 billion, to the State of
Alaska in royalty and taxes.
ConocoPhillips has approximately 1,000 employees in the state
and approximately 90 percent of them are Alaskan residents. They
are competent, motivated and active in the communities where
they live and operate. They care about Alaska and they believe
that the work they do makes Alaska a better place to live.
Through subcontractors and support industries, employment is
generated for thousands of additional Alaskans. He stated:
The past, present and future of ConocoPhillips and the
State of Alaska are inextricably linked. As we move
forward as partners for perhaps the next 50 to 100
years, we believe there must be a mutual recognition
of and respect for the interests of each of us. We
have to try together to answer the question, 'How do
we balance the factors that affect each of our
interests in a way that makes us both successful.'
MR. WENZEL said that unfortunately the balance in SB 305 is
decidedly in favor of the state and at the expense of
established investors like ConocoPhillips. It sets an aggressive
level of state-take when take is considered in conjunction with
other corporate income tax obligations, property tax obligations
to the state, the property and sales tax to the state, and other
tax obligations to the state municipalities - royalty
obligations to the state and the various oil and gas surcharges
imposed by the state, plus additional fees and costs that apply
in the permitting process whenever a development moves forward.
This is all on top of its corporate income tax obligations to
the federal government. It is no surprise that this layer upon
layer of government take has a negative impact on investment,
job creation and growth in Alaska.
He said that ConocoPhillips reluctantly supported the bill even
though it thought the tax increase was too high to achieve the
state's goal of increasing investment. It punishes companies
that have made long-term investments and are returning dividends
to the state in the form of jobs, royalties, corporate income
taxes and property taxes. He would oppose the bill except for
the fact that it has enabled all the companies to come together
with an agreement to advance the gas pipeline under the Stranded
Gas Development Act and advancing the gas pipeline has been one
of ConocoPhillips' top priorities.
3:55:51 PM
He began discussing ConocoPhillips' long-term investments and
its role in minimizing North Slope production decline and the
impacts ELF has had on those developments.
He said that ConocoPhillips has been involved with the
exploration and development of 14 satellites that have resulted
in new production on the North Slope (slide 2). They were
predominantly marginal developments, 50 million barrels (MB) per
day to 150 MB per day, and were developed as a result of the
favorable fiscal treatment given under the ELF (economic limit
factor). Development of those satellites played a significant
role in reducing North Slope decline and enabling 1.9 MB of oil
to be produced compared to 1989 predictions. This is equivalent
to discovering a Kuparuk-size field and has added more than $5
billion in revenues to the State of Alaska (slide 3).
In addition to the satellite developments, ConocoPhillips
continues to explore and drill and has drilled more than 40
exploration and appraisal wells in the last five years and it is
committed to continuing exploration.
MR. WENZEL said the ELF did what it was supposed to do - put oil
in the pipe and grow Alaska's economy. He understood the state's
view on the limitations of the current ELF-based severance tax
system, particularly at high prices. He believed that a wise and
enduring tax policy could be developed and that the Governor's
proposed production tax that is intended to reflect profits from
that production and includes incentives to encourage investment
in the future and fair transition provisions that recognize the
cost of investments already made was such a policy.
Nevertheless, he said that SB 305, as proposed, would result in
an additional $1 billion per year to the state at today's
prices. This unprecedented increase would more than double the
existing severance tax payments for ConocoPhillips.
3:58:40 PM
MR. WENZEL displayed slides that illustrated different fiscal
structures. His view was that a balanced fiscal structure was
critical to future investment in both oil and gas - and the
future of oil production in Alaska is primarily dependent on
existing fields. He emphasized that SB 305 differentially and
adversely impacts ConocoPhillips' production from its legacy
fields and a significant transition plan was necessary to allow
an equitable conversion from the old tax system to the new tax
system. He also added that a new PPT would impact Alaska's
global competitiveness for investment.
3:59:41 PM
MR. WENZEL said there have been many questions about the
relationship of the PPT to the fiscal contract negotiations
under the Stranded Gas Development Act (SGDA). The purpose of
the Act was to encourage new investments and to develop the
state's stranded gas resources by establishing fiscal terms in
advance with as much certainty as the Constitution of the State
of Alaska allowed. However, he said the line between gas and oil
production is not clear-cut. They exist together in reservoirs;
the wells that are drilled produce them both. Many of the
investments necessary to develop gas will also develop oil.
Ultimately this means that the fiscal certainty provided by the
state under the SGDA will be inadequate if only applied to gas.
He elaborated:
The Administration has recognized the need for the
Legislature to approve any agreement that included
fiscal certainty for oil, but that Administration was
unwilling to consider fiscal certainty for oil under
the terms of the current production tax statute. It
was, instead, willing to propose to the Legislature a
new oil tax that is before you that could become part
of a fair and durable fiscal regime for both oil and
gas. But the Administration's position has been clear.
The new production tax has to stand on its own. In
other words, it had to represent something that the
Legislature, itself, would accept as wise tax policy
in the absence of a deal on the natural gas pipeline.
For our part, this oil tax increase, on the average of
$1 billion for the industry at today's prices, is not
something that ConocoPhillips would have found
acceptable if we didn't think it would progress and
ultimately result in an agreement to move forward on
the gas pipeline project.
So, once again, the proposed oil tax increase by the
Administration is a balance. On the one hand, it
provides a foundation for fiscal stability for the oil
and gas-related businesses of the producers in the
Alaska. This stability is essential for the future
investment including investment and the development of
the gas pipeline project. On the other hand, the
producers must pay substantially more in taxes than
they would under the current regime.
4:02:03 PM
MR. WENZEL moved on to discuss the future of North Slope oil
production in Alaska (slides 10 - 13) saying:
Even with the proposed incentives, the state's
consultant has acknowledged that production resulting
from wildcat exploration will only play a small role
in increasing revenues under the PPT. The core legacy
fields, such as Prudhoe and Kuparuk, would still
produce over 80 percent of the total North Slope
production in 2015 providing the base infrastructure
on [which] these smaller fields will depend.
The already discovered heavy oil resource will play a
much more significant role in the future of the North
Slope. However, the state's consultant acknowledged
that technology limitations and development costs will
constrain heavy oil in the near term and it could be
many years before this production reaches its
potential. Yet this heavy oil resource base - it's
huge - and published data suggests that in-place
volume are greater than 20 BB. This is a key resource
for Alaska and the Legislature should consider a
structure that would best enable its development.
MR. WENZEL said the bill has been designed to encourage new
investors to come to Alaska and ConocoPhillips fully supports
that and believe they would be beneficial to both the state and
the industry. ConocoPhillips has already made partners of
several of them. But, he said, the terms that attract new
investors come with a cost and the Governor's tax increase
mainly targets ConocoPhillips' legacy production assets -
Prudhoe and Kuparuk. The increase is unprecedented for those who
have invested tens of billions of dollars to develop the North
Slope and stayed in Alaska through difficult times, including
periods of very low prices.
4:07:03 PM
He cautioned that any time the government raises taxes, it takes
money away from the private sector that could be used for
investment and continued job growth. He also thought that higher
rates would not be in the long-term best interests of the state
either. He explained that new field sizes in Alaska are small
and Arctic operating and development costs are high.
ConocoPhillips spends a lot more time and resources assessing
upside potential and downside risks. Hopefully, it is right more
than it is wrong.
As we bear the greatest risk, it is fair that we
should be appropriately rewarded. We acknowledge that
the presence of tax credits reduces downside for the
investors, but conversely, higher tax rates
significantly reduce the upside potential, which is a
prime driver in our investment out.
4:08:34 PM
HE opined that hitting the right balance between tax rate and
the credits for reinvestment was critical to future resource
development in Alaska. ConocoPhillips reluctantly supported the
Governor's proposal in order to move forward, but the
Legislature must wrestle with the question of whether it will
attract long-term investment with a tax rate of 20 percent.
4:09:50 PM
MR. WENZEL began to comment on the importance of the transition
plan. Under the bill, a fraction of the producers' expenditures
for exploration, appraisal and development capital incurred over
the past five years may be deducted for purposes of calculating
a producer's monthly profit tax obligation. ConocoPhillips
supported that plan because it provided an equitable transition
to the new tax system and is an essential piece of the overall
balance reflected in this bill.
He related how their Fjord Field was developed as a stand-alone
satellite (and wasn't aggregated with Alpine for severance tax
purposes.) As a small satellite, it had a low ELF. Once the
decision was received from the Department of Revenue,
ConocoPhillips and its partners sanctioned the project and moved
forward. Fjord will be an 18-well roadless satellite with first
rdth
production in late 3 or 4 quarter this year and production
would peak in 2007/08 at about 17,000 barrels per day. Total
capital costs are expected to be around $300 million and while
oil and gas prices have significantly increased over the last
few years, so have material and labor costs, and ConocoPhillips
is expecting it to cost $30 million than when originally
sanctioned. He explained further:
A majority of costs associated with developing the
Fjord project will have been expended prior to the
bill becoming effective. Without the transitional
investment expenditure plan, only costs associated
with 2007 and 2008 winter drilling programs would be
eligible for the PPT. As previously discussed, the
project was sanctioned on the letter ruling from the
Department of Revenue, assuming the field would pay
full state corporate income tax, full royalty,
property tax, but little or no severance tax. However,
under this new bill, the development would now be
subject to a 20 percent PPT rate. Without the
transition plan, the increase in the fiscal terms will
result in a reduction of $100 million in the gross
value of this project and a 6 percent reduction in our
average return at a $40 ANS West Coast price.
ConocoPhillips is currently working on two other
satellites in addition to Fjord - these are Nanook,
due to start up in 2006, and West Sak 1J, which came
on line late 2005. All of these projects will have
similar value-loss impacts without the transition
plan. In addition, there are several other projects
undertaken in the last few years, which are now almost
fully developed and will have value eroded as a result
of the PPT. Our view is in order to insure these past
investments are equitably treated, the transition plan
is essential.
I would now like to ask Marianne Kah, again, our Chief
Economist from ConocoPhillips, to spend a few moments
discussing how this proposed tax change might impact
Alaska's competitiveness and from the perspective of a
global investment.
4:12:04 PM
^ConocoPhillips, Marianne Kah, Chief Economist
MARIANNE KAH, Chief Economist, ConocoPhillips, said she is also
part of the corporate planning department at its headquarters in
Houston. She wanted to talk with them about ConocoPhillips' view
of Alaska's competitiveness on a global basis. She started out
saying that she was sympathetic to the state's position on this
issue.
4:14:03 PM
MS. KAH turned to slide 18 to show the average capital and
operating costs for Alaska and other locations around the world
over the last decade (excluding exploration and appraisal). It
included the TAPS tariff, but not additional costs for Alaska
that would reflect the high cost of the Jones Act tankers. Even
without those costs, Alaska has higher capital and operating
costs than other regions ConocoPhillips invests in. She
explained:
Cost needs to be taken into account when we set our
tax take. The countries with the lowest cost can
afford to have higher tax rates while remaining
competitive and similarly, higher cost countries need
to offset these conditions with lower tax takes.
4:15:54 PM
The next slide showed a graph of total costs and total
government take of revenues. She said the most competitive
quadrant is the low cost/low tax quadrant of the graph she was
showing. Entities in that quadrant were not trying to offset
their lower costs with higher tax rates. They were trying to
remain very competitive. The Gulf of Mexico was in that quadrant
and the UK was almost there. A lot of U.S. states would be in
that quadrant.
4:16:09 PM
CHAIR WAGONER asked what taxes the Gulf of Mexico has. "Isn't
the reason the Gulf of Mexico is so profitable is because there
are hardly any federal taxes; there are no state taxes. So, that
in all reality, that should be in the low cost/low tax."
MS. KAH agreed and said that was the intent - to get investors
to the Gulf.
CHAIR WAGONER asked if the feds were seriously thinking about
raising taxes in that area.
MS. KAH replied that the only reason the feds were thinking that
way is because prices are high now, but that discussion would go
away if prices went down.
4:17:28 PM
SENATOR DYSON asked if her chart says that under the ELF the
government take is 60 percent of revenues.
MS. KAH replied yes, including state and federal.
SENATOR DYSON asked if under the PPT it would go up to 67
percent and change.
MS. KAH replied yes. The state's consultant said it was a 6
percent increase, but ConocoPhillips number was slightly higher.
She surmised that was because the consultant had used the wrong
royalty number.
Back to the quadrant, Ms. Kah, said that clearly the low
cost/low tax places are trying to make themselves very
competitive. The low cost/high tax countries are still trying to
attract investment. The high cost/low tax countries have lower
tax rates because they offset higher costs. The high cost/high
tax areas on the graph don't get as much investment because they
are not trying to offset their higher costs with a lower tax
rate. Norway is an example of a country in that category.
4:19:23 PM
SENATOR ELTON asked if she was including royalty as part of the
tax structure and, if so, why. The royalty is the state's oil
and is part of the lease condition.
MS. KAH replied that royalties were in her number and she was
trying to show the numbers the way an investor would look at
them. "And, you know, the dollars are dollars."
SENATOR ELTON said he understood her point, but one thing that
has consistently bothered him is that it is very easy for her to
chart what the costs may be for ConocoPhillips, but it doesn't
show him anything about what the risk might be. For example,
ConocoPhillips doesn't have to worry about employees because
they are working in Alaska, but if they were working Nigeria, it
would. Likewise, if they were working in Saudi Arabia, compounds
would have to be built, but not in Alaska. "How do you factor
those risks into an investment scenario?"
MS. KAH replied that he was beating her to the punch and those
costs were considered.
When it comes to political risk, we view Alaska very
favorably, which is why we've been here so many years.
Yes, we definitely take that into account. What I'm
saying is you need to take into account the cost, the
prospectivity and the political risk and look at all
of these factors, not several in isolation....
SENATOR ELTON asked if she had a chart for that.
MS. KAH answered that she didn't have a chart for that because
there were no numbers to show. Although some people can do
political risk ratings, her concern would be that their view of
political risk, even in the United States, is going up because
they are hearing talk about things like windfall profits tax.
"That is actually changing our view of the political risk in
what traditionally we have thought as an extremely low risk
country."
4:22:07 PM
SENATOR SEEKINS asked if she was talking about all government
taxes in trying to illustrate what was being left over for
ConocoPhillips.
MS. KAH replied that was correct.
SENATOR SEEKINS asked why she chose 1994 through 2003 as the
"slice of time" to chart.
MS. KAH replied that Wood Mackenzie did a study in 2004 where
they looked at every tax regime in the world and they had very
good data.
SENATOR SEEKINS asked if it reflected accurate data other than
for the PPT.
MS. KAH replied yes.
4:23:18 PM
SENATOR THERRIAULT explained the pressures government in general
was getting to raise taxes and the difficulty in trying to come
up with a tax structure that was stable. Other countries with a
progressive system of taxation were not having to change their
structure right now - and that was a form of stability.
So, we should be moving to a system that has some
progressivity to it with regard to price so that we
can get that long-term stability or a better chance at
long-term stability even if it's not locked in under
the terms of a contract. I'm wondering if you can make
some comments on that and it's my understanding that
in the back and forth between the Administration and
the companies there was a proposal by the companies
that did have a degree of progressivity to it.... It
did reflect an upward take for government as prices
moved up.
MS. KAH replied:
We really would be perfectly happy with a progressive
price structure. Our issue really is the overall take
level and the fairness in terms of the investments
we've made over the last five to ten years expecting a
certain risk payout that would suddenly be taken away.
But in terms of moving to a better system, we'd be
happy to have Alaska move to what they thought was a
fairer and better system - as long as we were treated
fairly in the process.
4:25:34 PM
SENATOR BEN STEVENS remarked that regardless of the difference
between ELF and PPT, he noticed that only three other areas
under the Wood Mackenzie study have a higher cost structure than
Alaska and nothing has changed in terms of the cost structure.
One is the Canadian Arctic and he asked what the others were.
MS. KAH replied Eastern Canada and Morocco. Only three areas
have a higher cost structure than Alaska. She said the slide
includes arctic conditions and transportation costs, but it does
not include Russia. Arctic Russia, in particular, would be an
equally high cost.
4:27:46 PM
Her point in slide 20 was to show that Alaska under ELF is in
sort of a middle of the road position and has moved up into the
high cost/high tax quadrant with the overall tax take level of
the PPT. She noted that peer areas, such as the Gulf of Mexico
and the UK North Sea, even if recent tax increases were taken
into account, were still significantly more favorable regimes.
"The high cost in the Arctic and the types of fields that are
likely to be found suggest that the proposed fiscal regimes
could detract rather than encourage significant investment."
She said commercial discovery size is what ConocoPhillips thinks
of as prospectivity and she illustrated those areas with a
graph. Areas with high prospectivity can generally assess higher
tax rates while maintaining investment. The Alaska North Slope,
however, has limited prospectivity as compared to other parts of
the world ConocoPhillips is exploring in. ConocoPhillips
believes tax rates should reflect that.
MS. KAH said the state's consultant assessed the competitiveness
of Alaska's tax rates by comparing the different regimes around
the world based on similar field sizes, but she pointed out that
that is not the way investors look at it. When they compare an
investment in Russia, for example, versus Alaska, they compare
the prospects of a 750 MB field versus a 50 MB to 100 MB field
that they might find in Alaska.
So, you really can't compare fields of the same size.
You have to take into account the higher prospectivity
in terms of the tax rates that that project will be
able to support.
Any greater prospectivity in Russia may compensate for
the higher tax rates. When you add political risk in,
you know, it may change that picture, but I think you
need to take that higher prospectivity into account. I
also want to point out that it's not really meaningful
to compare the competitiveness of Alaskan tax terms
with Russia, Azerbaijan and Angola at similar field
sizes. It's just not a meaningful comparison.
4:29:29 PM
MS. KAH talked about Norway, specifically, because the state's
consultant stated that it was comparable to Alaska, both in its
wealth of natural resources and its cost structure. But, she did
not believe it was a good comparison, because Norway does, in
fact, have a lower cost structure and better prospectivity.
However, she pointed out that it has significantly higher taxes
than Alaska. Another reason she didn't think that model was
helpful to them was because true production in Norway has
declined by 17 percent since 2001 in a fairly high price
environment. In her view, Norway was not getting enough
investment, because its tax structure was not in line with its
cost and prospectivity position.
4:30:26 PM
Slide 22 looked at petroleum industry reinvestment rates. MS.
KAH said that investors needed stable fiscal terms with tax
rates that are commensurate with the cost structure and the size
of the opportunity. Alaska's tax regime has offered that in the
past and that is why ConocoPhillips has found it an attractive
place to invest. But with recent tax increases in locations
around the world, she was becoming concerned that global tax
takes were reaching a point where private companies were finding
it challenging to invest. She thought one of the main reasons
the reinvestment rates in the green bars of the graph had not
moved with the oil price was because the tax rates were reaching
a point where companies are not finding enough investments that
were attractive and meet shareholder returns - along with other
considerations. Prices were expected to cycle down to lower more
normal levels, so companies are not anxious to invest with
prices this high. She also noted that there is a lag time in
developing projects creating a delay in supply response.
MS. KAH said she believed that tax rates around the world were
playing a key role in lagging reinvestment rates, because
companies were worried they would make investments and
governments would change their tax rates afterwards. Longer-
term, she was concerned that private oil companies were being
pushed out of the conventional oil business and being forced to
invest in alternative energy supplies and things that have more
favorable tax terms.
4:32:04 PM
CHAIR WAGONER asked how conservative companies would stay if
crude oil prices remain high.
MR. KAH responded that she has long since given up trying to
forecast oil prices. Several factors suggest that prices are
exaggerated today. The first is that there was extraordinary
global economic and demand growth in 2004, which is not being
repeated. China had unusual factors that year - a power shortage
during which it used diesel generators and an extra 300,000
barrels per day temporary need - and that is now gone.
They are now seeing a price response to higher prices in terms
of demand growth. The year 2005 had a demand growth rate that
was under the 10-year average, about 1 MB per day. Another
reason prices are staying where they are is that financial
investors were moving money out of equities and bonds and into
commodities, including oil.
I believe that money is overwhelming our oil markets
now and keeping the forward price curve at a very
elevated level - out five years. We've never seen them
invest five years out in the curve before.
4:34:24 PM
CHAIR WAGONER replied that he understood what she said about
China, be he was just in China and saw that they were building a
tremendous number of new roads and were getting ready to produce
their own cars.
They're back where we were probably in the 1920s and
they are getting ready to get rid of all their
bicycles and everybody with an income that allows them
will have a car. So if that does take a dip, I would
say it's not going to dip very long.
MS. KAH agreed and said that she also thought prices would come
down, but to a higher number.
4:35:03 PM
SENATOR ELTON referenced slide 6 that indicated Alaska's take
was $60 a barrel, but Ms. Kah was saying to not count on prices
staying and that they are artificially being held up. He asked
where she thought prices would cycle down to and why that wasn't
reflected in slide 6.
MS. KAH reiterated that she doesn't try to forecast oil prices
any more. They look at their projects through a range of prices.
The financial community consensus seems to be $40 a barrel.
Industry has to have the most conservative view on this, because
it takes the risks.
She emphasized that when people talk about price, they need to
talk about cost structure, too. It is really high today. Goldman
Sacks believes replacement costs today are $50 per barrel. The
service industry has not kept pace with the spending level, but
eventually it would make the investment and costs would come
down. People think a big windfall is taking place when, in fact,
a lot of money is being absorbed by higher costs.
4:37:13 PM
SENATOR ELTON asked for the same graph of the state's nominal
take out to 2025 at $60 oil (shown on slide 6) to be done for
$40 a barrel oil - if that was what ConocoPhillips based its
decisions on.
MS. KAH replied that she did not say that was how its decisions
were made.
I said we're more conservative than the financial
community and that's all I can say. This is really
competitively sensitive information and we wouldn't
want our competitors hearing how we base our decisions
because we bid against them in auctions around the
world.
SENATOR ELTON asked to have the Department of Revenue prepare
that chart.
4:38:10 PM
MS. KAH said another concern from a major company's point of
view was that she sensed a bias in the proposed tax regime in
favor of the new versus the legacy investors.
I believe there's a common misperception that smaller
and medium sized petroleum companies have lower return
requirements than the majors. As an economist, I'd
like to point out that they have a higher cost of
capital than we do. It's because they're less
diversified and, therefore, they are viewed as being
more risky - both by the bond community and the equity
investors. So they have a higher cost of capital and,
therefore, should have higher return requirements than
we do.
Companies that don't invest and return adequate
returns to their shareholders are no longer with us
today. So, I don't think you want companies to come in
here who aren't going to invest conservatively and
return sufficient money to their shareholders. I would
imagine - and I don't want to speak for the
independents - but I would imagine that they would be
comparing Alaska's tax regime to the Gulf of Mexico,
the United Kingdom, Canadian oil sands. Those are
common areas where they would be frequent investors.
But the state's consultant concluded that tax rates in
these locations were more competitive than existing
and proposed rates in Alaska.
What I worry about if countries decide that they are
going to have high taxes today, it's possible that
only government controlled oil companies with
different objectives like energy security are going to
be willing to invest in conventional oil - getting
back to the point I said before. I fear that we are
all collectively being pushed out of conventional oil
into LNG projects or into coal to liquids or something
that is not conventional oil - because tax rates are
getting too high in several locations around the
world.
And there's another concern created by the high tax in
favor of new versus legacy investors. As partners, we
think about what will it be like to have a large
number of small players active in the environmentally
sensitive North Slope. The costs associated with
environmental protection are really high and I know
ConocoPhillips has very high standards on
environmental protection and as well as state and
federal governments and local governments - have the
same standards. And this level of environmental
sensitivity may be new to many of these players.
That's something that we worry about.
4:40:35 PM
MS. KAH made a case for why the state should want ConocoPhillips
to stay and what it has to offer the state. ConocoPhillips has
been a long-term investor in Alaska - it has the size and
financial strength to carry out project of any size. It has the
skills to manage large and complex projects and has substantial
experience in both developing and operating in the Arctic
region. ConocoPhillips, in particular, has substantial
experience in heavy oil production, both in Venezuela and
Canada, and has leading technology that processes the heavier
crudes. It has the second largest refinery in the United States
that can be upgraded to handle heavy crude. It also has strong
commercial acumen and access to markets, which allows projects
to be designed to maximize the full value of the resource.
ConocoPhillips is the second largest gas marketer in the United
States. It has strong risk management skills and a long-term
investment horizon. This means they invest year-in and year-out
and won't leave when market conditions get tough.
The last point Ms. Kah wanted to make was why the majors should
be viewed as desirable investors by showing the committee their
three-year average upstream spending in billions of dollars
versus the spending of various independent petroleum companies.
Majors can bring a lot of investment dollars into the state
provide the terms were competitive. She concluded saying:
The tax proposal as introduced is the upper bound of
what we believe is reasonable given the totality of
the deal. I thank you very much for your attention and
I'm going to turn it back to Brian to finish.
4:42:23 PM
^Wenzel - question and answer
MR. WENZEL said he had identified some language changes to
clarify and improve the bill. Among other things, the changes
concern how eligible deductions and credits are identified and
the value at point of production and how that value should be
calculated. He hoped to be able to offer that language shortly.
He said he wanted to summarize several key messages from today's
discussion. One was that the proposed production tax results in
a more than doubling of the effective tax rate over the current
system.
In isolation, we would not view this change as
reasonable, fair or appropriate, particularly given
the state's current budget surplus. However, as a
foundation for oil and gas fiscal stability that
facilitates future investment in Alaska, the balance
proposed in this bill is something that ConocoPhillips
will reluctantly support.
Second, the North Slope has a huge heavy oil resource
that is already significantly disadvantaged from a
technology, quality and cost perspective.
Incentivizing this resource will be key to increasing
production levels in Alaska.
Third, a transition plan from the current production
tax system to the new system is essential to insure
equitable treatment of our legacy investments. Many of
these investments were associated with the development
of marginal assets that were justified on the basis of
the prior ELF system. Qualifying these legacy
investments for deduction against the PPT is an
essential part of the balance reflected in this bill.
Finally, the tax rate associated with this bill pushes
Alaska into a high-cost, high-tax bracket as compared
to many other regimes around the world. This will
affect the risk/reward balance the companies will
evaluate before deciding to invest here. Before you
accept the rate reflected in the Governor's bill, you
must first be comfortable with the potential risks of
future investment that such a high rate imposes. I
would like to reiterate that Alaska and ConocoPhillips
are aligned as partners on many very important goals -
increasing investment in Alaska, increasing Alaska's
oil and gas production, increasing Alaska's
competitiveness, developing long-term relationships
with proven partners for long-term mutual benefit.
In closing, many factors have to be considered by a
government in choosing the appropriate tax rate for an
industry as complex as the oil and gas industry. Cost
structure including distance to market, prospectivity,
potential field size, reservoir quality, regulatory
constraints and the desired level of investment are
perhaps but a few of the factors that need to be
considered. Today, Alaska is challenged in each of
these areas and the fiscal regime needs to recognize
this. Thank you for considering our views.
4:45:50 PM
CHAIR WAGONER said that ConocoPhillips was the first of the big
three companies to sign an understanding with the Governor that
it accepted certain terms on the gas pipeline and he asked if
the PPT was being discussed at that time or did ConocoPhillips
request it or did it come up after.
MR. WENZEL replied that the PPT had been discussed prior to that
date, as early as last July. It is typical for an administration
to approach potential taxpayers about a change in the tax
system. ConocoPhillips found the base terms of the contract
acceptable in October.
CHAIR WAGONER asked if ConocoPhillips didn't at least consider
that the Legislature would discuss fixing ELF or going to a
different tax structure in the near future.
MR. WENZEL replied no, their investment analysis doesn't
typically look for a change in a tax regime in Alaska - in other
countries perhaps - and certainly not a doubling of the
production tax rate.
SENATOR ELTON asked him to clarify what he meant by "doubling"
pointing out that the tax doubles only if the price of oil stays
at $60 a barrel. It doesn't double if it's at $40 a barrel.
"It's certainly a loss to the state if it's less than $27 a
barrel."
MR. WENZEL apologized and agreed that the doubling happens at
current prices, not at all price levels.
SENATOR DYSON clarified that when he asked the question earlier,
it's only a 6 or 7 percent change from government's total take
now.
MR. WENZEL replied that was correct.
SENATOR DYSON continued by pointing out that at least some of
that may be offset by the credits.
MR. WENZEL responded that the tax credits were built into that
analysis.
SENATOR DYSON asked if he figured in how much ConocoPhillips
would invest in exploration and development in Alaska when he
made the chart.
MR. WENZEL replied yes; it was his best estimate for both
ConocoPhillips and the industry.
SENATOR DYSON remarked, "That's fascinating when we all have
difficulty predicting oil prices, but you're able to predict the
investments for not only yourselves, but the industry."
MR. WENZEL replied that ConocoPhillips felt it was necessary to
make an estimate and show what it felt was a dramatic impact in
terms of where the state of Alaska is moving on its overall tax
regimes.
4:51:04 PM
SENATOR GENE THERRIAULT referenced the tax credit mechanism and
rd
the ability for them to be sold in SB 185 [from the 23
Legislature] and asked if ConocoPhillips could purchase tax
credits in Alaska under the existing system.
MR. WENZEL replied that he didn't think so, but he couldn't say
for sure.
SENATOR THERRIAULT requested that information along with what is
paid for $100 worth of credit. He thought it might be advisable
for the state to have some limits on what credits could be
bought for even though the consultant advised to let the free
market set that rate.
4:51:46 PM
MR. WENZEL replied that the trading of the credits was
structured for the benefit of the state.
The alternative is to simply write producers a check.
I believe the state actually structures the system
with credits such that in a scenario where prices are
low, they don't have to cut those checks - rather
those credits remain out there.... I would have the
same view that you should allow the free market system
to work and value those credits as appropriate.
SENATOR THERRIAULT responded that he thought Mr. Wenzel was
right, but he thought the value had some "leakage."
4:53:31 PM
SENATOR BEN STEVENS asked to go back to slide 19 based on the
Wood MacKenzie 10-year study from 2004 and said, "I find it
fascinating that no matter what we do, we're in the high cost
portion of production on a global scale." He asked if the tax
credits would move Alaska left on the horizontal scale, why
wouldn't the tax credit in the PPT cause it to move to a lower
tax structure.
MS. KAH replied, "It's because the overall tax rate is higher
and that has more than offset the additional tax credits."
SENATOR BEN STEVENS responded that this was another way to
demonstrate what Dr. van Meurs said - that the tax credit has
low sensitivity and the high sensitivity is in the tax rate.
MS. KAH replied, "It's less sensitivity than the overall tax
rate."
MR. WENZEL agreed.
SENATOR BEN STEVENS said he still couldn't fathom why the state
hadn't moved down the cost structure with tax incentives.
MS. KAH explained that that graph charted costs with no
government take factored in.
SENATOR BEN STEVENS repeated that if tax credits were factored
in, "We still don't see a movement."
MS. KAH replied they wouldn't put the tax credits in that graph.
Those would be represented on the chart in the lower government
take.
SENATOR BEN STEVENS remarked, "But it should if it had a
significant impact. It should still move us down more towards
the center."
MS. KAH agreed saying:
Right, it should have moved you to lower overall tax
rate, but the increase in the absolute tax rate from
13 percent in ELF to 20 percent in what's being
proposed more than offsets the improvement in the tax
credits.
4:56:17 PM
SENATOR STEVENS said he thought the chart illustrated the
overall insignificance of a tax credit in the scheme of things -
in terms of what Legislators can do to make Alaska more
competitive.
4:56:53 PM
DARREN JONES, Vice President, Commercial Assets, ConocoPhillips
replied:
I think the way you think about that is that the
increased tax rate would raise that Alaska ELF higher
than even that circle is. The tax credits bring it
back down a little bit. The other way to look at it
might be the way you're suggesting is. You'd just have
a tax increase, the rate increase, and you could say
the tax credits lower your effective costs. Then you
might move it to the left a little bit. In that case,
you would be higher up on that scale.
4:57:55 PM
SENATOR BEN STEVENS added, "We'd be higher on the scale, but
maybe further to the left."
MS. KAH agreed and added that depended on where those numbers
were accounted.
CHAIR WAGONER commented that it didn't much impact
ConocoPhillips, but it might hugely impact an independent.
MR. WENZEL agreed.
SENATOR BEN STEVENS switched direction to Standard and Poor's
recommendations that highlighted capital expenditures for
ConocoPhillips were about $11.6 billion globally last year.
MS. KAH replied that sounded right.
SENATOR BEN STEVENS asked how much of that was in Alaska.
MR. WENZEL replied about $700 million.
SENATOR BEN STEVENS asked if ConocoPhillips has budgeted about
$10 billion for capital expenditures in 2006.
MS. KAH replied that sounded right.
SENATOR BEN STEVENS asked how much of that was budgeted in
Alaska.
MR. WENZEL replied roughly HH $700 million again.
SENATOR BEN STEVENS asked if ConocoPhillips had spent $700
million a year consistently regardless of its global
percentages.
MR. WENZEL replied that ConocoPhillips' investment over the last
five years was closer to $2.5 billion, an average of $500
million per year and stated:
No, I can't say that we hold $700 million as our
capital expenditure level year-in and year-out on a
go-forward basis. It's dependent on the projects we
see and the economics of the projects.
SENATOR BEN STEVENS asked of the $700 million allocated for
expenditure in 2006, how much was for exploration and how much
was for maintenance and development.
MR. WENZEL replied that it was in the neighborhood of $100
million.
SENATOR BEN STEVENS asked for a breakout of ConocoPhillips'
exploration, development and production figures. He said he
found a 1999 quote from a former chairman that said:
'When we look beyond 1999' - and you remember what
1999 was - it was $12 oil - he says - 'The future of
Alaska will be shaped on four factors: the
availability of the resource base, our cost structure,
oil price and the state's fiscal and regulatory
polices.' The question I have to ask is how would you
rank those?
He said that they have shown the committee that the availability
of the Alaska resource base doesn't compare on the global
perspective - at the most 50 MB to 100 MB field, maybe a 400 MB
field and the cost structure won't change. The only thing the
state can change is its fiscal regime. "So, when you're talking
to us, you want to tell us that the most number one important
thing is the thing that we can change!"
MS. KAH replied, "I think I've said that is really why we've
stayed in Alaska all these years - because we viewed Alaska as
having a stable fiscal regime.... And our people aren't getting
shot at here either."
SENATOR BEN STEVENS said, "The one thing that has the
flexibility for change is what is before us and the flexibility
to skew that one way or another off the global competitiveness
is the tax rate and the credit rate. No matter what we do here
in Juneau, we're not going to change the cost structure of the
North Slope. No matter what we do in Juneau, we're not going to
increase the probability of finding the next 500 MB field. He
emphasized that the tax change only occurs every 17 to 25 years
and that is why Alaska is viewed as a stable regime.
He further noted that the $40 a barrel figures Senator Elton was
requesting were in the Department of Revenue's fiscal note.
SENATOR ELTON said he would check the fiscal note.
SENATOR BEN STEVENS said he thought the number one issue was
fiscal stability.
5:06:35 PM
SENATOR THERRIAULT asked what the crossover point was between
the status quo and the PPT.
5:07:15 PM
MR. WENZEL replied that their estimate is around $25 under the
PPT.
SENATOR THERRIAULT asked what the crossover point was at 25/20.
MR. WENZEL didn't have that number.
CHAIR WAGONER asked if there were further questions. There were
none. He thanked everyone for their comments. There being no
further business to come before the committee, he adjourned the
meeting at 5:08:27 PM.
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