Legislature(2005 - 2006)BUTROVICH 205
03/01/2006 03:30 PM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| SB305 | |
| Chevron Corporation – John Zager, General Manager, Alaska Area | |
| Pioneer Natural Resources – Pat Foley, Manager, Lands and External Affairs | |
| Ultrastar Exploration Llc, Jim Weeks, Managing Owner | |
| Alaska Venture Capital Group - Ken Thompson, Managing Director | |
| 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
March 1, 2006
3:35 p.m.
MEMBERS PRESENT
Senator Thomas Wagoner, Chair
Senator Ralph Seekins, Vice Chair
Senator Ben Stevens
Senator Fred Dyson
Senator Bert Stedman
Senator Kim Elton
Senator Albert Kookesh
MEMBERS ABSENT
All members present
OTHER MEMBERS PRESENT
Senator Hollis French
Senator Gene Therriault
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
02/27/06 (S) Heard & Held
02/27/06 (S) MINUTE(RES)
02/28/06 (S) RES AT 3:30 PM BUTROVICH 205
02/28/06 (S) Heard & Held
02/28/06 (S) MINUTE(RES)
03/01/06 (S) RES AT 3:30 PM BUTROVICH 205
WITNESS REGISTER
JOHN ZAGER, General Manager
Chevron Corporation, Alaska
Anchorage AK
POSITION STATEMENT: Supported SB 305.
KEVIN TABLER
Chevron Corporation, Alaska
Anchorage AK
POSITION STATEMENT: Supported SB 305.
PAT FOLEY, Manager
Lands and External Affairs
Pioneer Natural Resources Alaska
Anchorage AK
POSITION STATEMENT: Supported SB 305.
JIM WEEKS, Managing Owner
UltraStar Exploration LLC
3111 C Street, Suite 500
Anchorage AK
POSITION STATEMENT: Supported SB 305.
KEN THOMPSON, Managing Director
Alaska Venture Capital Group (AVCG)
Anchorage AK
POSITION STATEMENT: Supported SB 305.
ACTION NARRATIVE
CHAIR THOMAS WAGONER called the Senate Resources Standing
Committee meeting to order at 3:35:01 PM. All members were
present at the call to order. Chair Wagoner announced that today
would be the last of the stakeholder hearings.
SB 305-OIL AND GAS PRODUCTION TAX
3:35:01 PM
^Chevron Corporation - John Zager, General Manager, Alaska Area
JOHN ZAGER, General Manager, Chevron Corporation - Alaska, said
that Chevron's Alaska presence had changed a lot in the last
year. Here, Chevron is considered an independent; its asset base
is comprised of assets from the Heritage Chevron organization
and the Heritage UnoCal organization (UnoCal was acquired August
10, 2005).
Chevron is the fourth largest producer in the state and as such
is in a fairly unique position of not being one of the big three
producers or being privy to any of the contract discussions. It
has 382 employees or full-time contractors. It doesn't get the
scale of benefit that some of the large producers get nor the
incentives the small independents get. He said Chevron is the
dominant operator in Cook Inlet and that makes it the third
largest operator in the state. It impacts the Kenai economy as
well as providing energy to key customers - the Tesoro refinery,
Enstar, Chugach Electric, Agrium and Aurora.
MR. ZAGER related that Chevron is the only producer in the state
that has a relative balance of assets both in Cook Inlet and on
the North Slope. Roughly 40 percent of their barrels come off
the North Slope and 60 percent out of Cook Inlet. Both of the
production streams, in and of themselves, are large enough to
trigger the PPT.
3:39:51 PM
He presented map of both Chevron's North Slope and Cook Inlet
productions. Net production off the North Slope is 16,000
barrels of oil equivalent per day (BOEPD). He reviewed Chevron's
asset position in offshore Cook Inlet at 10,900 BOEPD and
onshore at 14,100 BOEPD.
In addition, Mr. Zager said, Chevron was probably the dominant
player in this morning's lease sale. It spent almost $7 million
to acquire 48 tracts, 430-some square miles of new exploration
land on the North Slope, mostly located south of Kuparek. Net
production off the Slope is approximately 16,000 BOEPD.
In Cook Inlet, Chevron operates 10 of the 15 offshore platforms.
Of those 10, eight are currently producing and two are shut in.
One of its assets on the west side of Cook Inlet is a gas
storage project that is being installed at Pretty Creek Field to
facilitate peaking needs in the winter. Chevron owns one-third
interest in Beluga Field, one of the big gas fields in the
Inlet. The biggest field in the Inlet is Trading Bay Field that
has five platforms, all operated by Chevron in partnership with
Forest Oil. The remaining offshore production is at Middle
Ground Shoals Field with four platforms. The middle two are
owned and operated by XTO; the northern and southern ones are
operated by Chevron and are currently shut in.
MR. ZAGER said that Chevron's Kenai gas storage facility at
Swanson River has become instrumental in meeting peak day needs
in the Inlet. It has met Enstar's peaking needs and sent gas to
Agrium, which is having serious problems with supply.
3:45:06 PM
MR. ZAGER said that most of the offshore platforms are 35 years
old and take a lot of maintenance. The last thing they want is
an environmental incident. He urged the committee to think
carefully before they turn over platform upkeep to new smaller
companies from down south that they hadn't heard of before or
that might be relatively thinly capitalized versus Chevron with
a balance sheet of $120 billion to stand behind the liabilities
in the Inlet.
3:45:47 PM
He presented an engineering offshore graph that indicated
production of 200,000 BOEPD from the early 70s to the present
when production is at 12,000 BOEPD.
He explained that watercut is used to define how many barrels
were water compared to oil and early-on it was 100 percent oil.
Now the watercut is at 90 percent. The same amount of fluid is
being produced, but it's 90 percent water. The increased cost of
separating the oil and reinjecting the water has to be compared
to the loss of production. [He displayed a graph of Trading Bay
Unit that indicated similar figures.]
He summarized that Cook Inlet oil is very high cost, primarily
because it is offshore, the facilities are big and a lot of
people work on them. Direct lift costs average out to $20 to $25
per barrel. Adding transportation, overhead and deductions for
quality of the crude and Chevron's breakeven cash flow is a
little bit north of $30 a barrel.
He explained that Wall Street grades corporations on earnings,
so the cost of actually getting the production on-line (the
depreciation amount) has to be added when earnings are
calculated. When Chevron adds depreciation, its earning break-
even point is in the $45 range. Production is very challenged
from both an earnings and a cash flow perspective.
MR. ZAGER pointed out their significant operational risk because
of the age of the facilities and the sensitive environmental
area they are operating in. "At some point you gotta say, 'Well,
with all the risks I'm taking here, am I getting a fair return
on the resources and the capital I've got canoed here?"
Another point he explained is that platforms are co-dependent on
each other for their expenses. Fixed costs, like the Nikiski
dock and the Trading Bay facilities, are shared among the
remaining platforms. So, as a group, they all need to maintain
their profitability.
The offshore component of Cook Inlet is the least able to afford
an additional tax. It is hard to plan your business on $55 or
$60 oil. Chevron shut in its two platforms about three years ago
when oil prices were in the low-to-mid $20s, because they were
losing money every day they were running. While the others were
not significantly positive, they were kept open; prices have
come up and they are okay for the time being.
3:51:51 PM
Update on Unocal joining Chevron. Most were glad that Chevron
ended up being the primary company. In January, Chevron
management made the decision to retain all its assets in Cook
Inlet and has committed to spending $200 million over the next
four years. It has decided to keep its offices in Alaska and is
expanding its positions here. He reminded them of the $7 million
they spent on the North Slope just this morning. When deciding
this, the company modeled all the economics with the existing
severance tax system, which in Cook Inlet means zero.
After seeing the Governor's proposal, Chevron's management team
ran a model under it and, "It did what it was advertised to do."
The best projects in the portfolio had their rate of returns
(ROR) lowered. They are the ones that are generating the most
profit and the tax would hurt their economics. The smaller
projects had their RORs go up. He believed that was because they
weren't generating such a large amount of profit that they get
hit with a profit tax, but they benefit from the capital credit
part of the equation. The average mean of their portfolio went
down a little bit. He pointed out that the enhanced terms of the
PPT could significantly expand the list of economic projects.
Changing the ratio by lowering the tax to 15 percent and
increasing the credit above it would also help, especially the
marginal projects and potentially bring a whole other list of
projects into the realm of consideration for investment.
MR. ZAGER reminded them that Chevron has partners on all their
properties and because of their unique position of being on the
Slope and in the Inlet, it would be in a dramatically different
tax situation than its partners. This could lead to further
misalignment on the economics.
3:59:16 PM
Cook Inlet has a gas supply issue, especially out a few years.
Having incentive is more about making sure energy is available
to run the economy and having additional gas supply that is
critical to the state's economy. He liked the idea of the state
sharing some of the risk up front in exchange for some of the
profit on the backside.
He said the Inlet currently lacks significant exploration.
Chevron has not looked for deeper pools because of the risks and
he was doubtful, although hopeful, that smaller independents
would come in and actually drill a well. Aurora and Forest have
been participating in some exploration, but beyond that, no one
has spent any money in "turning drill bits to the right."
4:01:57 PM
MR. ZAGER summarized that the PPT is a huge tax increase, but
Chevron would support the bill with the following stipulations:
· Treat Cook Inlet differently by lowering the tax rate
and/or increasing the capital credit
· Include an additional 5 percent capital credit (20/25)
for heavy oil or tertiary recovery (CO2) projects
statewide
· Keep the transition capital.
· Keep the $73 million exemption for any producer in the
state
He said they could probably tolerate one or two of those going
away, but if they all go simultaneously in the same direction,
they will be in a place where the bill didn't start out at all.
He recapped that Chevron is the only company that has assets
that are relatively balanced between Cook Inlet and the North
Slope; one is a much better asset than the other. Both of those
businesses are big enough to use up the $73 million tax credit.
He didn't think that Chevron should be disadvantaged in Cook
Inlet relative to Forest and Marathon from a tax perspective
just because it happens to have assets on the North Slope.
4:07:30 PM
MR. ZAGER thought lawmakers could consider letting a company use
the $73 million credit more than once if it owned property in
more than one geologic basin in the state if they wanted to
encourage production in as many parts of the state as possible.
Another lever that could help Cook Inlet and other areas is
making the credit a little higher than the tax rate to
incentivized exploration and production even more - especially
in selected areas of the state.
Another recommendation was to add an additional 5 percent
capital credit (20/25) for heavy oil and tertiary recovery (CO2)
projects statewide. Agrium's Blue Sky project has come to light
in the last few months and that uses coal to generate hydrogen
to fuel its fertilizer plant. That process generates tremendous
amounts of carbon dioxide, which is going to need to go
somewhere. One of the ideas was to use it for enhanced oil
recovery. He thought the concept was challenged technically.
4:10:02 PM
CHAIR WAGONER asked if he would use stainless steel and less
corrosive products for CO2 projects - basically installing brand
new systems.
MR. ZAGER replied yes; special tungsten type steels are needed.
New pipelines, well borers and platform components would have to
be replaced. They are basically talking about redeveloping the
field.
4:12:07 PM
MR. ZAGER emphasized that his company needs absolute clarity on
terms and definitions and summarized that the consequences of a
tax being too high would be that people would quit coming to the
lease sales. But, he was hopeful that the state would come up
with something workable.
4:14:05 PM
SENATOR FRED DYSON asked if Cook Inlet had a spot market, and if
it did, would that change Chevron's position on its long-term
contracts.
MR. ZAGER replied that Cook Inlet doesn't have a spot market;
everything is under long-term contract. A company needs to have
a market to commit to an investment. It would be hard to invest
if you have a pay out in three years and the Agrium plant closes
next year. He hadn't thought much about how a spot market would
work in the Cook Inlet.
SENATOR DYSON asked if long-term contracts there were keeping
more investment from happening.
MR. ZAGER replied:
On one hand, I would argue that long-term contracts
are causing more investment. It's no secret that we
have a contract with Enstar, which people comment on
from time to time. As a result of signing that
contract and having some assurance of a long-term
market, we've invested over $160 million in the gas
business since 2001 and have brought significant
additional reserves to market to help meet that
supply. If there were no long-term contracts, I keep
getting back to that you're going to have trouble
getting a story that you could sell to management that
you have a secure market. Without a market, your gas
isn't too valuable.
SENATOR DYSON said it had been represented to him that Cook
Inlet has a lot of gas and if that were produced, they wouldn't
have to be in such a panic to get North Slope gas down a spur
line - if only the market price of gas was operating.
MR. ZAGER responded that higher prices would incite more
exploration and the long-term price of gas in Cook Inlet has
historically been very low. Even today, it's the lowest price
gas in the United States. While offshore prospects exist, the
economics to drill for it haven't been there.
4:18:59 PM
SENATOR DYSON said Chevron is considering spending over $1
billion to bring a spur line down to Cook Inlet, but if all they
had to do was change the price, that would put them in an
interesting bind.
MR. ZAGER commiserated that people have gotten used to cheap gas
and that is not anywhere near to the market price.
4:20:45 PM
SENATOR STEDMAN asked to go back to slide 8 and asked if his
well structures were weighted more towards current costs rather
than previous costs from old wells where some of the production
has come from.
MR. ZAGER replied that most of their wells have been located in
Cook Inlet since the 60s and 70s when the fields were originally
developed and his projections were not forward-looking.
SENATOR STEDMAN surmised then that if they go back a few years
to when the price of oil was $20, the major oil companies'
balance sheets would be running blood red.
MR. ZAGER responded that a few years ago, they had more barrels
to produce. So the breakeven point would have been lower than
$30 a couple of years ago. They were also making a little bit of
money, but they also decided to shut in the Baker and Dillon
platforms in Middle Ground Shoal, because those were actually
bleeding cash.
SENATOR STEDMAN said the Legislature was trying to figure out
what the breakeven point is so that it could establish a tax
structure that would work for many years.
MR. ZAGER remarked that a 20 percent tax would basically take
away 20 percent of their profits, because right now the
severance tax is zero. It's hard to come up with a breakeven
point under that scenario.
4:25:15 PM
SENATOR ELTON asked to go back to slide 13 and asked Mr. Zager
if he was preparing a list of definitions that he wanted and
what his timeframe was.
MR. ZAGER replied that Chevron hadn't had the time to get to
those details together.
KEVIN TABLER responded that he struggled to just get a model
from last week. It was a work in progress.
4:27:40 PM
SENATOR FRENCH asked to see Chevron's tax burden under this
bill, because he thought that Cook Inlet should be exempted. It
has no significant exploration now and he couldn't see how it
would get more if the Legislature started taxing there.
MR. ZAGER said he supported that point of view.
SENATOR FRENCH remarked that a small company named XTO saw an
opportunity in the Inlet and gambled on buying into it during
times of low prices and low volumes. He asked Mr. Zager what he
thought they saw and how could they make a go of it in the
Inlet.
MR. ZAGER replied that it was hard to speculate about another
company's motives, but he assumed XTO got those assets at a
price it thought was worth the risk. They spent some money in
keeping production up, but he noted that XTO hadn't attempted to
expand anywhere else in the Inlet or to do any exploration.
4:30:33 PM
SENATOR STEDMAN asked if the Legislature incentivizes heavily,
should it not look at having an escalating tax rate at the high
end of oil prices, $60 - $120 per barrel, along with a large or
very attractive exploration credit.
MR. ZAGER replied that would be one approach, but he strongly
urged that whatever scheme the Legislature decides to use, to
keep it simple. He advised that when an oil company makes an
investment decision, it doesn't look at a single point, but
rather at a probability distribution starting at where
everything goes right and then works back to an average. If you
start clipping off the top end of the distribution, that will
affect the middle point. He likened it to telling another
business the state was going to take 20 percent of its most
profitable customers and give them a special tax.
4:33:22 PM
SENATOR THERRIAULT asked what element set the gas prices so low
in Cook Inlet.
MR. ZAGER replied that Cook Inlet had a surplus of gas in the
70s. It had a 200-year supply of gas. To monetize it, the owners
of the gas, Union Oil, constructed a fertilizer plant and
Marathon and Arco built an LNG plant to export the gas to Japan.
That gas has now been largely monetized and the Inlet is
entering a phase where the gas surplus is no longer there.
SENATOR THERRIAULT asked what is preventing the gas price from
coming up to the market rate now.
MR. ZAGER replied that the Agrium plant is one of the big
consumers and the price that they are willing to pay for gas to
generate ammonia and urea to sell in the world markets needs to
be competitive within that parameter. The LNG plant is a
dedicated supply and market. The remainder is to be set by long-
term contracts with Chugach, Matanuska Light and Power, and
Enstar that have the market and need the long-term gas supply.
MR. TABLER added that satisfying the additional market has
resulted in recent increased discoveries.
SENATOR THERRIAULT asked them to explore their concern over
complete understanding of terms and definitions to see if they
had specific areas of concern.
MR. ZAGER replied that terms are still a work in progress and he
thought the best solution was to work through AOGA for some
industry consensus on terminology.
MR. TABLER added that they have an 11 a.m. AOGA meeting tomorrow
and he would bring up the subject.
4:38:08 PM
SENATOR DYSON related that Agrium told him the price of fuel to
all of its competitors had gone up and they can make money and
sell their product at $5.50 gas. Agrium was thinking about coal
gasification at that price range, which he found surprising. It
was also represented to him by another party that the problem
with Cook Inlet gas price is the Regulatory Commission of Alaska
(RCA).
MR. ZAGER replied that he didn't understand that comment, since
the RCA only approves contracts, but it doesn't negotiate their
terms.
CHAIR WAGONER said he heard that decision was because of access
to the pipe.
MR. ZAGER replied that he thinks the whole access issue and its
affects on price and supply have been dramatically overblown.
SENATOR STEDMAN asked if they should consider changing the $73
million exemption for both the North Slope and Cook Inlet.
4:40:25 PM
MR. ZAGER replied that he wouldn't be here advocating that it be
lower, but thought it would be an appropriate place to make an
adjustment. If you want to motivate people to explore more, you
should dance with the people who are already here and not the
blind dates.
SENATOR STEDMAN asked if he thought the $73 million allowance
for everyone was fair.
4:41:57 PM
MR. ZAGER replied that all the companies would have their
opinions about which lever they could live with. For the big
producers, $73 million is a small percentage of the money they
would pay and is almost a throwaway. A company that doesn't
produce here could only aspire to get to $73 million some day
and until they do, they wouldn't pay any taxes. So, it's a very
important term for them. But, he said:
Chevron has done all those things. It's been here and
spent the money. We're big enough to trigger the $73
million. But we're not big enough to say it's a really
small percentage of our business. So, that's why, it
hits us in the Cook Inlet; it hits us on the North
Slope. We're kind of in a unique position in that
respect.
4:43:02 PM
CHAIR WAGONER thanked them for their presentation.
4:43:25 PM recess 4:49:18 PM
^PIONEER NATURAL RESOURCES - Pat Foley, Manager, Lands and
External Affairs
PAT FOLEY, Manager, Lands and External Affairs, Pioneer Natural
Resources Alaska, started with a brief history saying Pioneer
started business in Alaska in 2003 with three exploration wells
and acquired 150,000 acres in an areawide sale on the North
Slope. In 2004 it formed an exploration partnership with
ConocoPhillips and Anadarko covering a vast portion of the NPRA.
In 2005, it acquired a small interest in the cosmopolitan unit
and has an option to increase the interest up to 50 percent and
to replace ConocoPhillips as the operator.
Early in February it made a sanctioned decision to proceed with
its Oooguruk development on the North Slope and has begun
construction. It will include roughly 40 horizontal wells and he
anticipates recovering 50 million to 90 million barrels of oil.
Pioneer's total investment will be $450 million to $525 million.
Pioneer is the operator and owns 70 percent of Oooguruk; the
other 30 percent owner is E&I Petroleum, an Italian oil company.
At peak rate, Oooguruk will produce 15,000 to 20,000 barrels per
day and he expected it to peak in 2010 or a little earlier.
4:52:30 PM
He believed the challenges for new investors to be formidable
because the remaining fields are smaller, lower quality
reservoirs that are more remote and perhaps offshore. He
reminded them:
Last, we think there will be a focus on natural gas
and remember natural gas today has no market. It will
be another decade before North Slope natural gas has
any marketability. The North Slope clearly has some of
the highest costs of anywhere in the world and the
other big challenge is that the North Slope has very
long cycle times - even with success.... Realistically
production won't ensue for five years at the earliest
and as long as 10 years down the road. It's that long
cycle time that keeps many small companies away from
Alaska.
The largest risk in Alaska is uncertainty in calculating all the
risks accurately like oil price, fiscal policy change,
regulatory process and access to existing infrastructure on the
North Slope. Because of the long cycle times, they have to take
an extremely long view of price. Although the price of oil is
$50 a barrel or higher, over the last 10 years, the price has
been closer to $25 a barrel on average.
For a company like Pioneer that has no Alaska
production, the oil price in 2006 is irrelevant. We
look totally to what oil price will be over the next
two or three decades to understand whether our
investment decisions today are wise.
4:57:44 PM
Under the ELF formula, only very large fields would ever pay a
significant portion of severance tax. The exploration credits
entitle an investor to recoup either 20 or 40 percent depending
on the distance from existing infrastructure. The exploration
incentive credit fiscal system is primarily what encouraged
Pioneer to invest significantly in some of the infrastructure-
challenged areas - such as the far west NPRA. When they learned
the severance tax policy was subject to being changed, they
became quite concerned that it might be detrimental to a company
like Pioneer and that it would be a departure from the fiscal
system that prompted it to invest in the state in the first
place.
MR. FOLEY said he recognized that the existing severance tax
program on the North Slope was not sustainable and was pleased
that the PPT taxes profits as opposed to revenues. It makes
sense that additional assessments are added after companies have
recouped their investments. Pioneer is pleased to see the
provision regarding deductible transitional capital and agreed
with the Administration that the PPT would provide positive
economic incentives for investment. It would entice more
companies and ideas to Alaska that would lead to smarter field
development methods, drilling and production management.
Tradable tax credits are a particularly effective incentive for
exploration and development of new resources. Under the PPT the
Alaska challenges are at least partially offset by the ability
to monetize the credits shortly after investment. A tradable tax
credit would lessen the negative financial consequences of all
the inevitable dry holes that the explorers would drill.
However, he said Pioneer has a significant concern about the
potential liquidity of the tradable tax credits. It would
continue to invest heavily in Alaska for the next several years,
but only a handful of potential buyers will be able to buy the
tax credits and layer that on the fact that no single purchaser
can offset their tax through using the purchased credits by more
than 20 percent.
MR. FOLEY explained that the way the credit works, they would
sell the credits into the market at a discount and, no doubt,
the buyers of the credits are clearly entitled to recoup their
transaction costs. But he was concerned that the discount would
be significantly greater than the company's actual transaction
costs and that an individual could use more than one.
5:01:32 PM
CHAIR WAGONER said he was told that some credits had been sold
for 45 cents on the dollar - and not 95 cents. He asked if that
was true.
MR. FOLEY replied that he hadn't heard that. He said he had
personally sold credits that were discounted from full face
value by only a few percentage points. However, will all this in
mind, he suggested that the Legislature consider a refundable
credit program with limitations to protect the state's cash flow
in the event of low oil prices. The state could refund money at
a modest discount from the full face value. This would allow the
state and not a third-party buyer to benefit from any discount
that a seller might be willing to accept.
5:03:59 PM
MR. FOLEY stated that the PPT improves Alaska's competitive
position from the middle of the pack - according to Dr. van
Meurs. But he said to attract companies of Pioneer's size or
smaller, the system should be at least as competitive or more so
than U.S. Lower 48 opportunities.
Today with the prevailing high gas prices, there are
very, very large resource plays that are attracting
huge amounts of capital. When I talk about a resource
play, I'm talking about plays that specifically target
tight sands, shales, coal bed methane. These are plays
that again today are attracting huge amounts of
capital. They are relatively low risk; they're
relatively low cost and they have very short cycle-
times when compared to the North Slope. If Alaska
wants to improve its competitive position and attract
new investors, we believe that the Legislature should
take great care in making changes to the
Administration's proposal that would make it less
competitive.
5:05:45 PM
He liked exempting the first $73 million of cash flow from
taxation which would help deliver an investment climate more
consistent with the system that initially encouraged Pioneer to
explore in Alaska and would help offset high startup costs. The
obstacles to new investors are high and include small
discoveries, access to infrastructure and being risky or a
combination of all three. In summary, he said:
We believe that the proposed PPT is a balanced program
with appropriate incentives to encourage new
investment. We encourage the Legislature to carefully
evaluate the proposal and take care to ensure that any
changes make the state more competitive. Finally, we
would respectfully ask that you consider a tax credit
program that would allow the tax credits to be
refundable. A program like this would allow a new
investor the full-intended advantage of the tax credit
program.
CHAIR WAGONER thanked him for his presentation.
5:08:28 PM
SENATOR ELTON asked if he thought investment in Alaska was
competitive with that in other states.
MR. FOLEY replied that he couldn't comment on investment in
other states, but he worked in Alaska for companies that didn't
intentionally explore for gas and found it anyway. He felt that
there would be a way to monetize the gas assets, but that time
would be a decade or more away.
5:09:47 PM
SENATOR BEN STEVENS recapped that Pioneer worked with long-term
contracts and asked him if he could share the ranges of a stress
price analysis.
MR. FOLEY replied that he would be reluctant to share absolute
numbers that he considers proprietary. In general, in evaluating
a project, people tend to oversimplify investment decisions.
It's not a simple process. Pioneer considers a distribution of
costs, production rates and various price scenarios.
SENATOR BEN STEVENS asked how an increase in tax rate would
affect his evaluation.
MR. FOLEY replied that a modest tax increase doesn't have a big
impact on a small investor like Pioneer, but the refundable tax
credit and the $73 million floor do. He quipped that the
prospect of paying a large production tax is "relatively
attractive" to a small company whose production is now zero.
SENATOR BEN STEVENS pointed out that elements of the proposal
affect industry participants in separate ways.
5:13:25 PM
SENATOR THERRIAULT asked if he could have justified the royalty
modification in the 180(j) mechanism if the PPT was in place for
Oooguruk.
MR. FOLEY replied that hadn't been evaluated yet, but he
explained that when the investment decision was made on
Oooguruk, Pioneer's expectation was that the severance tax would
be zero or nearly so at the very end.
SENATOR THERRIAULT asked if his company ran models of the four-
year step back in royalty rates on Oooguruk and what the
calculations were.
MR. FOLEY replied yes. Pioneer's initial request was that the
royalty at Oooguruk be rolled back to a fixed 5 percent forever.
The state said that was not acceptable and a bargain was made
that at payout it would begin increasing and then after four
years go back to one-eighth or one-sixth depending on what the
lease terms were.
SENATOR THERRIAULT said he understood that the state's
evaluation after the fact was $58 million and net present value
was $9 million. He asked if he valued that particular four-year
stair step the same way.
MR. FOLEY replied yes, but added that it's also likely that
Pioneer's valuation would have been different.
5:16:09 PM
SENATOR STEDMAN went back to investment credits and said he
hoped they could be sold into the market in the high 90s.
MR. FOLEY said his expectation is that he could sell into the
market in the high 90s, but there aren't many buyers -
potentially four or five. He said that Pioneer is drilling an
exploration well this winter that would generate exploration tax
incentive credits at a rate of 20 percent and it is soliciting
bids to sell those credits, but it hasn't received offers yet.
5:18:03 PM
SENATOR BEN STEVENS said the credit is issued against a
liability to the state under the concept of the state having to
essentially refund that credit to its holder and asked if he
knows of any system that uses that policy.
MR. FOLEY replied that he knew of none.
SENATOR THERRIAULT asked how the five-year look back would
affect his company.
MR. FOLEY replied that Pioneer had only been in the state for
three years, but its investment was in the ballpark of $100
million and since the effective date of this proposal is July,
between now and July, Pioneer would invest approximately another
$50 million to $60 million.
5:20:51 PM
SENATOR STEDMAN asked if Pioneer would be better off if the
effective date were moved to January 1.
MR. FOLEY replied probably better off.
CHAIR WAGONER thanked him for his presentation.
5:22:13 PM RECESS 5:24:58 PM
^UltraStar Exploration LLC, Jim Weeks, Managing Owner
JIM WEEKS, Managing Owner, UltraStar Exploration LLC, said that
it is a small company that is all Alaska-owned and explores on
the North Slope. The company was formed in 2002 by Mr. Weeks,
John Winther and Dale Lindsey for the primary purpose of
exploring and developing leases on the North Slope.
He strongly supported SB 305 and the positions of existing
producers, independents and explorers on this issue. However he
offered the a few comments. He said UltraStar supported the
20/20 provisions and the $73 million deduction allowance in the
bill. But he has learned that the $73 million allowance could be
a difficult pill for the Legislature to swallow if it were
granted to all companies in Alaska regardless of the size of
their cash flow streams and it might be eliminated. He
encouraged them to not eliminate it and suggested an alternative
that would still provide incentives for exploration and
development of smaller fields. He suggested establishing a
ceiling above which larger companies would not get the $73
million allowance and below which the smaller companies would.
He elaborated:
There is a precedent for this in the "Charter for
Development," a 1999 agreement between the state, BP
and ConocoPhillips, that made the combination of ARCO
and BP possible. There are many provisions in the
Charter, but one of them requires BP and ConcoPhillips
to give preferential treatment to small producers
called "qualified producers." The Charter defines
qualified producers as those with worldwide assets of
less than $1 billion and establishes 5,000 barrels per
day as a maximum amount of crude oil that a qualified
producer can produce to receive the preferential
treatment.
MR. WEEKS said the Legislature could decide the appropriate
ceilings, but he thought this two-tiered approach would provide
incentive for entry by small newcomers without giving an
undeserved windfall to the established players.
5:31:23 PM
He said his last issue could be significant for small
independents. He explained:
It regards the exclusion of "amounts paid for purposes
of indemnification" on page 14, line 15, of the bill.
Small independents like UltraStar will need to
indemnify facility owners and operators who will
process our oil through their facilities. We will need
to purchase real, third-party, arms-length insurance
to satisfy these requirements. We will also need
insurance to meet the bonding and financial
responsibility requirement of the Departments of
Natural Resources and the Environmental Conservation
and the Alaska Oil and Gas Conservation Commission.
Depending upon the circumstances, membership in an oil
spill clean up cooperative may also be required. All
these costs can broadly be characterized as costs for
the purposes of indemnification and could arguably be
excluded when direct costs are calculated as defined
at line 21 on page 13.
Nearly 15 percent of the cost of the Winstar
exploration well at Oliktok Point in 2003 was for
insurance premiums. So these indemnification costs can
be significant for the little guy and should clearly
be deductible to determine direct costs. In his letter
transmitting this legislation to this committee, the
Governor said that a number of indirect costs are
listed in the bill and are to be excluded from the
calculation of direct costs. Indemnification is one of
the indirect costs listed. Trust me, Mr. Chairman,
there was nothing indirect about the $370,000 check I
wrote for the insurance premium on our last well. The
money went directly from our bank account into theirs.
I urge you to clarify your intent on this issue and
allow real, invoice-supported, arms-length,
indemnification costs to be included.
5:33:05 PM
CHAIR WAGONER thanked him and said they would review his
suggestions.
5:34:04 PM recess 5:34:25 PM
^Alaska Venture Capital Group - KEN THOMPSON, Managing Director
KEN THOMPSON, Managing Director, Alaska Venture Capital Group
(AVCG), said his is an independent oil exploration company with
a focus on the North Slope. AVCG is a consortium of 15
independent oil and gas companies and individuals from Kansas
with Mr. Thompson as an owner/investor from Alaska. His company
has acquired over 60,000 acres of exploration leases in five
prospect areas including new acreage acquired this morning. Its
exploration strategy is to explore in the central part of the
North Slope for fields in the 25 million to 100 million barrel
range, fields that may be too small for the giant producers, but
fields that can be produced profitably by smaller companies like
his. He believed there are hundreds of millions if not billions
of barrels of oil left on the North Slope in small fields.
He related AVCG's activities:
Our company is excited to report that the first
exploration well AVCG will participate in with an
ownership interest should have started drilling last
night - the Cronus exploration well about 10 miles
southwest of the Kuparuk Field, operated by Pioneer
Natural Resources. We plan two exploration wells next
winter and two the winter after that. With success, we
will continue exploring and producing.
MR. THOMPSON reported that his exploration budget for the next
three years is $46 million. He related further:
Many of you also know me as the past President of ARCO
Alaska, Inc. I also served as Executive Vice-President
for ARCO and head of global oil and gas exploration
for ARCO. I do have exploration and production
experience in over 20 countries throughout the world.
So, I'll also share my perspective in how I see the
new production profits tax bill in the context of
competitiveness in the world.
5:39:47 PM
In my first week as President of ARCO Alaska in June
1994, our ARCO staff reviewed state policies with me
to educate me abut the oil and gas industry in Alaska.
One of the key items they reviewed was the production
tax and the very complicated policy of ELF. Our
government affairs personnel told me that ELF was in
jeopardy - that the production property tax was going
to be changed. That did produce uncertainty in our
project economics forecast. Every year since then,
production taxes and the ELF have been topics and
uncertainty remains. Sixteen years have passed since
that meeting and every year I hear discussion about
production taxes, ELF and the imminent threat of
change. I welcome change and I say, "It's time to put
the new system into effect and let's get on with it."
MR. THOMPSON said he supported the PPT as long as the most
important terms remain as written. He supported the progressive,
profit sharing type structure versus a regressive, straight tax
on gross revenues. That way the state would share the gain at
high oil prices, but would also share the pain at lower oil
prices. This helps the smaller investors limit their downside
risk in the event of price collapse.
He reminded the committee that in addition to the 20 percent
production tax the state would receive from AVCG, it would also
continue to receive a 12.5 to 16.67 percent royalty share of all
revenues, the oil and gas property tax, corporate income taxes
and other revenues.
5:41:32 PM
The investment tax credit ass another key for AVCG. It creates a
very clear incentive to return that into investment for new
exploration rather than take the money outside. He thought it
would be attractive to other companies as well. But companies
that were already planning to send their cash flow outside
Alaska would probably not be convinced to keep it here.
MR. THOMPSON listed the things that should not be changed from
his company's position. He thought the 20/20 was a good balance
and neither should be changed. He said, "With a tax credit of 20
percent and redeployment of the tax savings back into our
exploration in the state, we can essentially drill an extra
exploration well for each five exploration wells we currently
have budgeted."
It was also important to keep the $73 million annual operating
cash flow standard tax deduction. However, he didn't see how the
public would understand and agree to that and suggested changing
the exemption to 5,000 barrels a day net. That would help AVCG
get its feet on the ground and it would be an easier policy for
the public to understand. A large producer could also get the
5,000 barrels exemption, but still have to pay production
profits tax on the other perhaps 295,000 barrels it produced.
5:45:58 PM
MR. THOMPSON then talked about the things that should be
changed. While being able to sell investment credits to others
in industry, if a new explorer does not yet have oil production
revenues to use the credits sounds good, the major producers are
the only ones who would buy the credits and, therefore, they
would set the price for them. That would not be favorable to new
explorers because the credits might be sold at only 70 - 75
percent on the dollar and the major producers would take 100
percent of the acquired credit against their production tax
bills. He recommended that:
The state consider establishing a pool of dollars from
the production profits taxes taken in to buy the tax
credits from small explorers. This makes sense. The
state would not be giving up anything because the
major producers would otherwise use the credits to
reduce their tax bill and reduce revenue to the state.
But using this approach, the small explorers could
turn around and reinvest the state-refunded credit
into new leases, seismic or exploration drilling. In
fact, the state might want to stipulate that if the
state refunded the tax credits to a company, that
company must use it for exploration or development.
Our company would support such a concept. Explorers
who don't want to do this option and reinvest in the
state, but just want the cash value of the credit
could sell it to the majors at 70 to 75 percent if
they prefer that option.
The section in the bill on "determination of net value
of oil and gas" listed direct costs that could be
deducted from gross oil revenues to calculate a profit
or "net value of oil and gas" to then be taxed at the
20 percent tax rate. For a new explorer in Alaska the
startup costs in the state can be very substantial,
particularly for smaller players. This can include
high costs for bonding, participation in the oil spill
consortium, Alaska Clean Seas, indemnification
insurance, etc. These types of costs should be clearly
mentioned in the bill as deductible.
MR. THOMPSON summarized his presentation saying he hoped the $73
million deduction remained and that legislators would remember
how important it would be for the smaller companies to establish
a foothold in Alaska. He elaborated the alternative he suggested
earlier saying:
As an alternative, however, to the $73 million profits
exemption, we offer that the state might choose to use
an approach that the state has already approved in the
1999 "Charter for Development of the Alaskan North
Slope" between the State of Alaska, BP and ARCO. In
that charter, there was a section entitled "Purchases
From Qualified Producers" that guaranteed that BP and
ARCO (now ConocoPhillips) would agree to offer to
purchase any "qualified producer's" crude oil so that
new entrants or small producers would not be
disadvantaged in marketing their oil. In that section
there was a clear definition of a protected "small
producer." Actually, the charter called such a
"qualified producer."
I quote from the charter: a 'qualified producer' means
an entity with assets of less than $1 billion
(worldwide) which produces not more than 10,000
barrels of gross working interest ANS liquid
hydrocarbons per day. Again, we hope the deduction
provision remains in the bill. If there is opposition
in the end, AVCG does hope the small companies are
protected in some way. Perhaps an innovation such as
using the Charter guidelines may help.
He thanked them for the opportunity to make comments.
5:50:55 PM
SENATOR THERRIAULT asked him for an example of a market where
credits would be sold at the low range of 70 to 75 percent on
the dollar.
MR. THOMPSON replied that he didn't have such an example. AVCG
just used that figure in its model. The past market has been at
90 to 95 percent of the credit and he hoped that continued. This
is new ground and a lot more credits might be available through
PPT than ever before at one time and that could affect their
value. Even if the credits go for 95 percent, the majors would
turn around and use the full 100 percent. He, on the other hand,
as a small producer, pledged to use the full 100 percent for
exploration activity.
5:52:41 PM
SENATOR BEN STEVENS asked him to expand on page 3 of his
testimony where he said he panicked at a 25 percent PPT. He
asked him to compare his position as a small company that
wouldn't be subject to the tax rate for many years to that of
Mr. Foley's of Pioneer, who said it wouldn't affect him.
MR. THOMPSON replied that AVCG hoped to be a sizeable producer
in three years and at the taxation level. However, when he ran
the economics for its prospects at a tax rate of 25 percent, he
found that:
Interestingly, it wasn't too much different than the
current system - not dramatically different, anyway,
as far an investor's rate of return. However, when we
ran the tax rate at 20 percent, we found that our near
term cash flow was better. The state was taking less
although, after payout and after the tax credit was
gone [indisc.]. The state was taking more share of the
profits and we were having less cash flow. I'm okay
with that, because that means we get a faster payout
with a better cash flow near term and we get a higher
rate of return. And when I go to Houston in the last
year and try to get partners, this rate of return,
this rate of return hurdle, sometimes for other
partners, particularly in the private equity
markets.... I think we could attract more capital to
our company for additional drilling. So, that's really
why I say that the rate of return wasn't all that much
different at a 25 percent rate, but at a 20 percent
rate, it really did help us....
He also informed them that private equity was not as available
for exploration as for development.
SENATOR BEN STEVENS commented that the mechanisms in SB 305
affect each company differently. For a company that is seeking
capital, a fixed rate at 20 percent improves its ability to do
that - even though it is not a ratepayer for many years.
CHAIR WAGONER asked what would happen to his company at rates of
25/25 and 25/30.
MR. THOMPSON said he would run those numbers for him, but his
feeling was that 25 percent just didn't seem fair.
5:58:30 PM
SENATOR THERRIAULT said even if the tax rate is locked in for a
long period of time and the state is not getting the activity it
wants, it could probably be lowered without much trouble. But,
the state might not be able to increase the rate as easily.
MR. THOMPSON said he understood that concept, but it would be
nice to know everything up front. He repeated that the 25
percent crosses his fairness threshold.
SENATOR THERRIAULT asked what effective corporate tax rate he
expects for his operation.
MR. THOMPSON replied that AVCG used a 9.4 corporate tax rate
from a conservative standpoint.
SENATOR THERRIAULT also noted that when they are talking about
"government take," that includes the federal government take as
well.
6:01:19 PM
SENATOR STEDMAN commented that when they talk about the
difference between a 20 tax and 25 percent tax, from a company's
point of view, the total government take is changed only by
about 2 percent.
6:01:55 PM
CHAIR WAGONER thanked Mr. Thompson for testifying and said the
meeting would be recessed until tomorrow. He then recessed the
meeting at 6:03:33 PM.
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