Legislature(2003 - 2004)

05/06/2003 04:10 PM RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                          May 6, 2003                                                                                           
                           4:10 p.m.                                                                                            
MEMBERS PRESENT                                                                                                               
Senator Scott Ogan, Chair                                                                                                       
Senator Thomas Wagoner, Vice Chair                                                                                              
Senator Ben Stevens Senator Kim Elton                                                                                           
Senator Georgianna Lincoln                                                                                                      
Senator Ralph Seekins                                                                                                           
MEMBERS ABSENT                                                                                                                
Senator Fred Dyson                                                                                                              
OTHER MEMBERS PRESENT                                                                                                         
Representative Chenault                                                                                                         
COMMITTEE CALENDAR                                                                                                            
SENATE BILL NO. 185                                                                                                             
"An Act providing for a reduction of royalty on certain oil                                                                     
produced from Cook Inlet submerged land."                                                                                       
     MOVED CSSB 185(RES) OUT OF COMMITTEE                                                                                       
PREVIOUS ACTION                                                                                                               
SB 185 - See Resources minutes dated 5/5/03.                                                                                    
WITNESS REGISTER                                                                                                              
Mr. Mark Myers, Director                                                                                                        
Division of Oil and Gas                                                                                                         
Department of Natural Resources                                                                                                 
400 Willoughby Ave.                                                                                                             
Juneau, AK  99801-1724                                                                                                          
POSITION STATEMENT: Supported SB 185.                                                                                         
Mr. Tad Owens, Executive Director                                                                                               
Resource Development Council                                                                                                    
121 W. Fireweed, No. 207                                                                                                        
Anchorage, AK 99503                                                                                                             
POSITION STATEMENT: Supported SB 185.                                                                                         
Mr. Larry Houlle, General Manager                                                                                               
Alaska Support Industry Alliance                                                                                                
4220 B Street                                                                                                                   
Anchorage, AK                                                                                                                   
POSITION STATEMENT: Supported SB 185.                                                                                         
Mr. Kevin Tabler, Manager                                                                                                       
Land and Government Affairs                                                                                                     
Union Oil                                                                                                                       
Anchorage AK                                                                                                                    
POSITION STATEMENT: Supported SB 185.                                                                                         
ACTION NARRATIVE                                                                                                              
TAPE 03-41, SIDE A                                                                                                            
        SB 185-ROYALTY REDUCTION ON CERTAIN OIL/TAX CRED                                                                    
CHAIR SCOTT  OGAN called the Senate  Resources Standing Committee                                                             
meeting  to order  at 4:10  p.m. Present  were Senators  Wagoner,                                                               
Elton, Lincoln and  Chair Ogan. The Chair announced SB  185 to be                                                               
up for consideration.                                                                                                           
MR. MARK MYERS, Director, Division  of Oil and Gas, Department of                                                               
Natural Resources (DNR),  said he believes the purpose  of SB 185                                                               
is  to keep  the Cook  Inlet infrastructure  in production  for a                                                               
longer period  of time, particularly the  offshore platforms. All                                                               
of  the  Cook  Inlet  platforms  are late  in  field  life:  peak                                                               
production occurred  in the late  '60s to early  '70s. Production                                                               
has  steadily   declined  with  the   exception  of   the  recent                                                               
discoveries at Redoubt on the  Osprey Platform. The state can use                                                               
its statutory authority to offer  royalty reduction to provide an                                                               
incentive  to  keep the  platforms  in  production. DNR  will  be                                                               
required to make an individual finding for each platform.                                                                       
The division  has a great  deal of data  on the economics  of the                                                               
reservoir properties.  It can determine, fairly  accurately, when                                                               
a field will  cost more to operate than  oil production warrants.                                                               
At  that point,  companies have  to decide  whether to  close the                                                               
infrastructure.  Lowering   royalty  at  a  strategic   time  can                                                               
actually extend  the useful  economic life of  the field.  SB 185                                                               
would  reduce  the 12.5%  royalty  to  5% under  certain  trigger                                                               
prices, thereby  extending the  field life up  to 14  months. Mr.                                                               
Myers explained:                                                                                                                
     In doing  so, the state  foregoes royalty on  the front                                                                    
     side that it would otherwise  get, but extends the life                                                                    
     of  the field  and picks  up  some royalty  on the  far                                                                    
     side....   There   may    be   additional   incremental                                                                    
     opportunities  off  those   platforms  for  exploration                                                                    
     wells. We  know some of  them do have  some exploration                                                                    
     prospects  that  some  of  the  current  operators  are                                                                    
     considering,  or  a  new operator  now  might  buy  the                                                                    
     facility at a  later point in time ... so,  all in all,                                                                    
     the goal  of the bill is  to extend the lives  of these                                                                    
MR.  MYERS  showed the  committee  maps  illustrating Cook  Inlet                                                               
fields and facilities,  oil and gas units, oil and  gas pools and                                                               
recent activity in  the Inlet. He explained  that multiple fields                                                               
share the  on-shore processing facilities used  by the platforms.                                                               
They want  to keep the  entire infrastructure in tact  because if                                                               
individual  platforms are  pulled off,  the overall  economics of                                                               
the processing  facility will go  down and  the cost will  go up,                                                               
accelerating the decline of the other platforms.                                                                                
He found  that platform economics  cluster under two  groups. For                                                               
one group the economic break  was approximately 1,200 barrels per                                                               
day;  the other  clustered around  750. The  division used  these                                                               
economic  criteria  to  put  the   platforms  into  two  separate                                                               
categories  to  generalize.  He  noted, "If  you  looked  at  the                                                               
individual platform-by-platform  economics, you  would do  just a                                                               
normal royalty process, which is available under current law."                                                                  
MR.  MYERS told  members the  fiscal note  details the  amount of                                                               
current  oil  being produced  on  the  platforms, the  break-even                                                               
point, and when they would be  expected to cross over that point.                                                               
A $20 netback oil price was assumed for that analysis.                                                                          
MR. MYERS said  the negative to the state on  the royalty side is                                                               
$200,000 to $600,000  per year and he doesn't think  that's a lot                                                               
considering the value  of extending the life of  the platforms in                                                               
the  Inlet.  The value  of  an  incremental discovery  using  the                                                               
infrastructure  could  well  exceed  the value  of  the  foregone                                                               
SENATOR ELTON said it seems  to him, without this bill, companies                                                               
would make a decision about exploration  or about what to do with                                                               
the existing  infrastructure earlier.  He wanted  to know  why an                                                               
earlier decision may not be as beneficial as a later decision.                                                                  
MR.  MYERS  replied  that  companies have  to  look  at  multiple                                                               
factors when they get near the end  of field life and one of them                                                               
is  the cost  of abandonment,  which is  pretty high.  Generally,                                                               
when  a  platform is  abandoned,  the  equipment is  removed  for                                                               
multiple platforms,  not for  a single  platform. The  state does                                                               
not  want the  companies  to  pull out  three  or four  platforms                                                               
because   that   would  have   a   significant   impact  on   the                                                               
infrastructure   and  accelerate   the  decline   of  the   other                                                               
platforms.  So, extending  life earlier  allows for  planning and                                                               
exploring  of  other  possibilities that  might  keep  production                                                               
MR.  MYERS added  that in  reality, royalty  reduction will  help                                                               
only  during a  limited window.  The state  gets a  12.5% royalty                                                               
from a  platform of 1,200 barrels  per day. If the  royalty drops                                                               
to 5%,  that eliminates about  85 barrels per day.  As production                                                               
declines further, you'll go through  the 85-barrel decline pretty                                                               
fast. That's why the window is only 14 months. He explained:                                                                    
     The one concern  you would have in a bill  like this is                                                                    
     if  you're getting  near that  number, you  might choke                                                                    
     your wells back, you might  try to get below the amount                                                                    
     to trigger...If  you look  at (g)(2) I  think it  is in                                                                    
     the  bill, there's  language in  there specifically  to                                                                    
     disallow  your  royalty  reduction   if  it's  not  for                                                                    
     reservoir related...So, mechanical  choke backs or lack                                                                    
     of facilities is not an acceptable reason....                                                                              
     We  tried  to  prevent   cases  where  there  might  be                                                                    
     artificial gaming  of it. So,  we think  generally that                                                                    
     we'll have  the ability to  make sure it's  a reservoir                                                                    
     related  decline. This  allows  them up  front to  know                                                                    
     they're going  to get the royalty  reduction they would                                                                    
     get  under   the  statute   anyway  and   there's  more                                                                    
     certainty. Now  it would trigger  a little  bit earlier                                                                    
     in the  cases of  some platforms. That's  why it  has a                                                                    
     negative fiscal  note here.  So, you  get a  little bit                                                                    
     advantage, but  again, that certainty,  if it  helps in                                                                    
     the economics of someone operating  for a longer period                                                                    
     of  time, they  can  maybe plan  some additional  work-                                                                    
     It also might  help in the sale of  properties. You may                                                                    
     have current operators that decide  that it isn't worth                                                                    
     the incremental  investment to go  out there  and drill                                                                    
     that  exploration well,  that  deeper  prospect. A  new                                                                    
     company may come in. XTO  is an example [of] who bought                                                                    
     the platforms  and have done  very well. So,  we expect                                                                    
     to see  trades and  ownership. This provides,  again, a                                                                    
     little more value  to the platform and  again, we think                                                                    
     it's  healthy  as  long  as  the  proper  environmental                                                                    
     protections  and bonding  are  in place  that there  be                                                                    
     sales and transfers and new ideas come in....                                                                              
SENATOR ELTON  asked if the  state is creating a  disincentive to                                                               
invest in infrastructure or technology  with the 1,200 barrel per                                                               
day provision,  because if they  do that, recovery might  go back                                                               
MR. MYERS replied that in reality,  it's doubtful - the cost of a                                                               
work-over for  a well would  be in  the hundreds of  thousands of                                                               
dollars. Drilling  new wells costs  several millions  of dollars.                                                               
The difference  in royalty wouldn't  be enough to cover  the cost                                                               
of that sort of activity.                                                                                                       
CHAIR OGAN  praised the quality  of the division's  fiscal notes.                                                               
He said he learns a lot from them and they are very helpful.                                                                    
SENATOR WAGONER said  two of the platforms they  are referring to                                                               
used to  be known as  Shell A and  Shell C. Cross  Timbers bought                                                               
those  platforms.  Cross Timbers  was  a  smaller company,  which                                                               
changed  its name  to  XTO.  That's an  example  of  a major  oil                                                               
company  selling  off  some  of  its assets  to  a  smaller  more                                                               
independent company.  XTO has  had a  drilling program  for about                                                               
three or  four years and  produces a  little over 4,000  to 4,600                                                               
barrels per  day. The smaller companies  are basically production                                                               
companies, not exploration companies.                                                                                           
CHAIR OGAN asked if XTO  water-flooded one of the [platforms], it                                                               
might  qualify for  the 1,200-barrel  rather than  the 750-barrel                                                               
per day provision.                                                                                                              
MR.  MYERS   replied  the  division  looked   at  the  economics,                                                               
including the  water and gas  handling. XTO would  certainly fall                                                               
in the higher end of the  750 group, but its water-flood is about                                                               
one-seventh of the ones in the  1,200 barrel range.  He surmised,                                                               
"So, they have  a much lower operating cost than  the other group                                                               
of platforms."                                                                                                                  
MR. MYERS explained when platforms  are clustered, some are going                                                               
to fall in the  higher end and some in the  lower end within that                                                               
cluster. XTO  uses about 3,000 barrels  of water a day  for water                                                               
flooding; other platforms  are using 20,000 to  30,000 barrels of                                                               
water per  day. He said  the division is  trying to get  close to                                                               
the actual  economics of the  operating expenses of  the platform                                                               
and get a little ahead of  the game to give some incentive beyond                                                               
that.   However, the  division does  not want to  get too  far in                                                               
front because that would result in a large fiscal note.                                                                         
CHAIR  OGAN asked  if  he  had staff  to  verify  whether or  not                                                               
companies are manipulating the flow mechanically.                                                                               
MR. MYERS replied  that work would be done by  the Alaska Oil and                                                               
Gas  Conservation   Commission  (AOGCC),   which  looks   at  the                                                               
mechanical issues.  His division  looks at the  royalty reporting                                                               
and reservoir  management through unit plans.  The division would                                                               
assist  the  AOGCC   in  the  process  and   change  the  royalty                                                               
accounting system to look at platform factors.                                                                                  
SENATOR  LINCOLN  said Gary  Carlson  with  Forest Oil  told  the                                                               
committee that Forest  Oil put off the decline  with an extension                                                               
from one to  three years. She asked why Mr.  Myers said this bill                                                               
extends the life of the field for up to 14 months.                                                                              
MR. MYERS replied that he  looked at the projected decline curves                                                               
for the reservoir. If the production  goes to around 1,200 or 750                                                               
and flattens more,  they would be in that window  longer. He used                                                               
a fairly  straight rate  of decline based  on the  division's and                                                               
producer's data, which he thought was predictable.                                                                              
CHAIR OGAN asked,  "Why not give them a break  to the point where                                                               
it  doesn't  hurt the  state  fiscally  but still  provides  some                                                               
MR. MYERS replied for two reasons:                                                                                              
     One is  you want to be  out front a little  bit of when                                                                    
     they actually  reach that negative cash  flow situation                                                                    
     so they have  a clear incentive to  keep producing. You                                                                    
     have to  use a price of  somewhere - you don't  know if                                                                    
     the price  is going to be  $18 or $24 or  if it's going                                                                    
     to be  $20. So,  again, our sensitivity  was done  at a                                                                    
     specific  price. You  could do  it  on multiple  prices                                                                    
     [indisc.]  but then  you are  really prophesizing  into                                                                    
     the future....                                                                                                             
He said  the division  tried using just  1,200 barrels,  but that                                                               
produced a very high fiscal note and it was not realistic.                                                                      
He said  the bottom  line is to  get to a  zero fiscal  note. The                                                               
division  will have  to look  platform-by-platform and  either be                                                               
precise or be negative on some and positive on some.                                                                            
CHAIR OGAN asked  him what other incentives might  be offered for                                                               
Cook Inlet.                                                                                                                     
MR.  MYERS  answered  that  a  number  of  years  ago  a  royalty                                                               
reduction was  given to six  fields that were discovered  but not                                                               
yet  known to  be in  production. Two  were oil  fields, Sturiski                                                               
Point and  Redoubt Shoals,  and four were  small gas  fields. The                                                               
state decided  it was worth  the gamble  to lower the  royalty to                                                               
5%; almost all  of those fields are now in  production or near to                                                               
it. The reduction was limited to  the first 25 million barrels of                                                               
production or 35 billion cubic feet of gas.                                                                                     
SENATOR SEEKINS arrived at 4:37 p.m.                                                                                            
MR. MYERS  said two  other royalty  incentives have  been offered                                                               
for Cook  Inlet. The first  was a discovery royalty,  which means                                                               
under certain conditions  a company could get a 5%  royalty for a                                                               
10-year  period after  initial discovery.  The second  applies to                                                               
utilities and is  the higher valuation contained in SB  50 and HB                                                               
57, where  the state uses  the contract price rather  than either                                                               
the prevailing value or the higher oil value.                                                                                   
SENATOR LINCOLN asked for a list  of the fields that now have the                                                               
5% royalty.                                                                                                                     
MR. MYERS agreed to provide  that list. He noted those incentives                                                               
were offered for early-in-life fields.                                                                                          
SENATOR  ELTON asked  Mr. Myers  if the  division predicated  the                                                               
fiscal note  on $20 per  barrel oil,  whether there would  be any                                                               
way to  peg the  royalty rate  reduction so if  the price  of oil                                                               
goes up the reduction would be  reduced and vice versa to protect                                                               
the state and the company.                                                                                                      
MR.  MYERS replied  that  could be  constructed  and wouldn't  be                                                               
unusual  in  a  traditional royalty  reduction  application,  but                                                               
because these  platforms are so  late in  the life of  the field,                                                               
the differential  is not huge when  one runs the numbers.  One of                                                               
the bill's purposes  is to provide certainty  and using different                                                               
numbers would run counter to that purpose.                                                                                      
SENATOR  SEEKINS  asked, in  reference  to  page  3, line  25  if                                                               
someone could  shut down below  750 in the  last two days  of the                                                               
quarter to get the royalty reduction.                                                                                           
MR. MYERS replied a company could,  but a protection was built in                                                               
to (g)(ii) on page 4 for that kind of gamesmanship.                                                                             
SENATOR WAGONER moved to adopt  CSSB 185(RES), version \H, as the                                                               
working document before the committee.                                                                                          
SENATOR ELTON  objected but then  removed his objection  and CSSB                                                               
185(RES), version H, was adopted.                                                                                               
SENATOR WAGONER moved  a conceptual amendment to  allow the legal                                                               
drafter the latitude  to change some wording in the  bill to "the                                                               
first  day of  the  month  following the  month".  There were  no                                                               
objections and it was so ordered.                                                                                               
MR. TAD OWENS, Executive  Director, Resource Development Council,                                                               
supported SB  185 for  all the  reasons stated  by Mr.  Myers. He                                                               
said  it is  appropriate  for the  state  to consider  incentives                                                               
designed  to  prolong  the  life   of  existing  fields,  protect                                                               
critical  infrastructure and  encourage opportunities  for future                                                               
investment. SB 185 addresses each of those goals.                                                                               
MR.  LARRY  HOULLE,  general  manager,  Alaska  Support  Industry                                                               
Alliance, supported SB 185 for the reasons previously stated.                                                                   
TAPE 03-41, SIDE B                                                                                                            
MR.  KEVIN TABLER,  manager, Land  and Government  Affairs, Union                                                               
Oil, said  Union Oil  is the predominate  operator in  Cook Inlet                                                               
and supported  SB 185 for  all the previously stated  reasons. It                                                               
would help  extend the field life  so that new reserves  might be                                                               
found. Offering a  royalty reduction sooner would  be better than                                                               
CHAIR OGAN asked how a platform is shut down.                                                                                   
MR. TABLER replied that lease  provisions require the facility to                                                               
be removed. The  intent here is to put off  that ultimate removal                                                               
until the  economies of scale  support moving  multiple platforms                                                               
at one time.                                                                                                                    
SENATOR WAGONER moved  to pass CSSB 185(RES)  from committee with                                                               
individual recommendations.  There were no objections  and it was                                                               
so ordered.                                                                                                                     
CHAIR OGAN adjourned the meeting at 5:08 p.m.                                                                                   

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