Legislature(2005 - 2006)SENATE FINANCE 532

01/18/2006 03:00 PM RESOURCES

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03:17:30 PM Start
03:17:30 PM Profit Sharing Production Tax
04:28:06 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
-- Time and Location Change --
Joint w/(H) Resources
Petroleum Profit Sharing
Production Tax Systems
                    ALASKA STATE LEGISLATURE                                                                                  
                         JOINT MEETING                                                                                        
              SENATE RESOURCES STANDING COMMITTEE                                                                             
               HOUSE RESOURCES STANDING COMMITTEE                                                                             
                        January 18, 2006                                                                                        
                           3:07 p.m.                                                                                            
MEMBERS PRESENT                                                                                                               
SENATE RESOURCES                                                                                                                
 Senator Thomas Wagoner, Chair                                                                                                  
 Senator Bert Stedman                                                                                                           
 Senator Kim Elton                                                                                                              
 Senator Albert Kookesh                                                                                                         
 Senator Ben Stevens                                                                                                            
 Senator Fred Dyson                                                                                                             
HOUSE RESOURCES                                                                                                                 
 Representative Jay Ramras, Co-Chair                                                                                            
 Representative Ralph Samuels, Co-Chair                                                                                         
 Representative Carl Gatto                                                                                                      
 Representative Paul Seaton                                                                                                     
MEMBERS ABSENT                                                                                                                
SENATE RESOURCES                                                                                                                
 Senator Ralph Seekins, Vice Chair                                                                                              
HOUSE RESOURCES                                                                                                                 
 Representative Jim Elkins                                                                                                      
 Representative Gabrielle LeDoux                                                                                                
 Representative Harry Crawford                                                                                                  
 Representative Mary Kapsner                                                                                                    
OTHER LEGISLATORS PRESENT                                                                                                     
 Representative Berta Gardner                                                                                                   
 Representative Ethan Berkowitz                                                                                                 
 Representative Les Gara                                                                                                        
 Representative Mark Neuman                                                                                                     
 Representative Jim Holm                                                                                                        
 Representative Kurt Olson                                                                                                      
 Representative Mike Hawker                                                                                                     
 Representative Max Gruenberg.                                                                                                  
 Senator Gene Therriault                                                                                                        
 Senator Hollis French                                                                                                          
 Senator Gary Stevens                                                                                                           
COMMITTEE CALENDAR                                                                                                            
Overview:  Profit Sharing Production Tax                                                                                        
PREVIOUS COMMITTEE ACTION                                                                                                     
No previous action to record                                                                                                    
WITNESS REGISTER                                                                                                              
Dr. Pedro van Muers, Economist                                                                                                  
Consultant to Legislative Budget and Audit Committee                                                                            
Alaska State Capitol                                                                                                            
Juneau, AK  99801-1182                                                                                                          
POSITION STATEMENT:  Presented the overview                                                                                   
Mr. William Corbus, Commissioner                                                                                                
Department of Revenue                                                                                                           
PO Box 110400                                                                                                                   
Juneau, AK 99811-0400                                                                                                           
POSITION STATEMENT:  Introduced Dr. van Muers                                                                                 
ACTION NARRATIVE                                                                                                              
CHAIR THOMAS WAGONER  called the joint meeting of  the Senate and                                                             
House  Resources  Standing Committees  to  order  at 3:17:30  PM.                                                             
Present  were  Representatives  Carl Gatto,  Paul  Seaton,  Ralph                                                               
Samuels,  and Co-Chair  Jay Ramras.  Also  present were  Senators                                                               
Bert Stedman, Kim Elton, Albert Kookesh, and Chair Tom Wagoner.                                                                 
^Profit Sharing Production Tax                                                                                              
CHAIR  WAGONER  announced the  purpose  for  the meeting  was  to                                                               
receive a presentation by Dr.  Pedro van Muers and the Governor's                                                               
administration on  the subject  of profit  sharing oil-production                                                               
3:17:30 PM                                                                                                                    
MR.  WILLIAM CORBUS,  Commissioner, Department  of Revenue,  made                                                               
the introductions.  Dr. Pedro van  Muers was born in  Holland and                                                               
holds  a  PhD in  geology  and  economics.  Dr.  van Muers  is  a                                                               
petroleum economist who advises  only governments. In addition to                                                               
advising Alaska  on the pipeline  and gas  tax policy he  is also                                                               
currently  advising  Kuwait  and   Algeria.  Dr.  van  Muers  has                                                               
appeared before the Alaska State Legislature many times.                                                                        
DR.  PEDRO VAN  MUERS expressed  pleasure to  be involved  in the                                                               
introductory  briefing   for  the  idea  of   the  profit-sharing                                                               
production  tax. It  is an  opportunity to  provide feedback  and                                                               
exchange  ideas   for  the  purpose  of   preparation  for  final                                                               
3:21:09 PM                                                                                                                    
There are four main types of payments.                                                                                          
   · Royalties                                                                                                                  
   · Production tax (severance tax, ELF)                                                                                        
   · Property tax                                                                                                               
   · State corporate income tax                                                                                                 
Additionally  there   is  federal  corporate  income   tax.  This                                                               
presentation is about proposed changes in the production tax.                                                                   
The  current production  tax  for  oil is  12.25  percent net  of                                                               
royalty for  the first  five years of  production and  15 percent                                                               
thereafter.  These percentages  are  multiplied  by the  Economic                                                               
Limit  Factor (ELF),  which  is  between zero  and  one. The  ELF                                                               
lowers  the production  tax rate  for smaller  fields and  fields                                                               
with low productivity wells.                                                                                                    
3:23:33 PM                                                                                                                    
The ELF  formula is immensely  complex. It was developed  in 1989                                                               
and has served  the state well but no longer  gives good results.                                                               
The ELF tax is extremely sensitive  to the number of wells in the                                                               
field.  A large  number of  wells bring  a zero  tax and  a small                                                               
number of wells bring a higher tax.                                                                                             
3:25:57 PM                                                                                                                    
This  formula leads  to an  incentive for  oil companies  to keep                                                               
every well producing and to  build additional wells just to bring                                                               
the tax down.                                                                                                                   
3:28:30 PM                                                                                                                    
The ELF  formula reflects  economic conditions  in 1989  when oil                                                               
prices were  in the $14-$17  per barrel  range and the  values of                                                               
300  barrels of  oil  a  day for  well  productivity and  150,000                                                               
barrels  of   oil  a  day  for   field  productivity  represented                                                               
reasonable economic benchmarks.                                                                                                 
Also the  formula did not contemplate  the subsequent development                                                               
of  a  variety of  satellite  fields.  While the  production  tax                                                               
stimulated the development  of a variety of  marginal fields, the                                                               
benchmarks  are  now  outdated. Therefore,  an  overhaul  of  the                                                               
production tax is in the interest of the state.                                                                                 
The production tax has serious deficiencies.                                                                                    
   · ELF is no longer rational in relation to well productivity                                                                 
     and field production                                                                                                       
   · ELF is not responding reasonably in the case of field                                                                      
     production decline                                                                                                         
   · ELF does not provide a reasonable balance under a range of                                                                 
     oil prices                                                                                                                 
   · ELF does not provide a sufficient incentive for re-                                                                        
The tax has  serious deficiencies at this point in  time. A graph                                                               
showing  the  Kuparuk Oil  Field,  the  second largest  in  North                                                               
America,  shows that  the ELF  has already  declined to  zero and                                                               
will phase to zero in the next two years.                                                                                       
3:31:07 PM                                                                                                                    
ELF is declining  faster than production in  some fields. Kuparuk                                                               
is a  world-class oil  production field but  the ELF  has already                                                               
declined.  Dr. van  Muers insisted  it was  ridiculous to  have a                                                               
world-class oil  field that no  longer pays a production  tax. In                                                               
ten years, the only field that  will be paying is the Prudhoe Bay                                                               
field. Now is the time to  start changing the tax structure. Many                                                               
fields in the  North Slope are in the decline  mode. ELF does not                                                               
work well  during the decline mode.  If prices are high  there is                                                               
no reasonable balance.                                                                                                          
3:33:11 PM                                                                                                                    
[Representative Max  Gruenberg and Senator Fred  Dyson joined the                                                               
The Governor has proposed a  profit-sharing production tax (PPT),                                                               
which will  be a  complete replacement  of the  current ELF-based                                                               
version of the production tax on oil  and gas. This will be a law                                                               
of general application.                                                                                                         
The  reason for  the  profit-sharing system  is  because so  many                                                               
other nations have  been successful with it.  Norway, for example                                                               
is  a  lot  like  Alaska  in  that  they  produce  oil,  forestry                                                               
products, and  have a fisheries  industry. On a  per-capita basis                                                               
Norway produces  roughly half  of the  amount of  oil and  gas as                                                               
Alaska but Norwegians are 50 percent richer.                                                                                    
3:35:42 PM                                                                                                                    
The big  difference is  that with the  existing system  wealth is                                                               
slipping through the  fingers of Alaskans and  Norwegians hold on                                                               
to it. Many nations have proved the effectiveness of the PPT.                                                                   
The PPT is  calculated as a tax rate multiplied  by the corporate                                                               
cash flow  from production in Alaska  from oil and gas,  with tax                                                               
credits to  encourage investments.  It is  a consolidated  tax at                                                               
the corporate  level. The tax rate  will apply to the  total cash                                                               
flow of  the company from oil  and gas production. There  will be                                                               
tax credits to encourage production.                                                                                            
3:37:40 PM                                                                                                                    
It is a fair system that  has been implemented in many countries.                                                               
The PPT  is calculated  by taking  the gross  production revenues                                                               
based on wellhead prices, less  the producers lease expenditures.                                                               
If there  is a large  amount of cash  (high oil prices)  then the                                                               
share for  Alaska is  large. If  there is a  low amount  of cash,                                                               
then the share is low. It is a fair system for both parties.                                                                    
[Senator Hollis French joined the meeting.]                                                                                     
3:41:24 PM                                                                                                                    
There will  be tax  credits to encourage  investments based  on a                                                               
percentage of  the amount of  the investment. Losses in  any year                                                               
can be converted to tax credits  by multiplying the amount of the                                                               
loss  with the  tax  rate.  Tax credits  can  be transferred  and                                                               
traded. Explorers and independents will  be able to monetize part                                                               
of  their investments  immediately, thereby  strongly encouraging                                                               
Another  important purpose  of the  tax  credits is  to create  a                                                               
progressive tax.  Progressive taxes  can be created  in different                                                               
ways: tax  credits, uplifts, IRR payout  systems, sliding scales,                                                               
etc. The PPT is proposed to  convert losses to tax credits, which                                                               
can  be  traded and  transferred.  This  immensely increases  the                                                               
attractiveness of new interest investing in Alaska.                                                                             
3:44:37 PM                                                                                                                    
There will be  features to provide a favorable  tax structure for                                                               
explorers  and independents  and  encourage  exploration and  new                                                               
entrants to  Alaska and  it is desirable  to attract  smaller oil                                                               
companies to  the state. The  easiest way  to do that  is through                                                               
tax credits.                                                                                                                    
The proposed PPT:                                                                                                               
   · Is based on actual economics and generates tax when there                                                                  
     are reasonable profits                                                                                                     
   · Provides a reasonable balance between the state and                                                                        
     producers over a wide range of oil prices                                                                                  
   · Strongly encourages investment and re-investment in the                                                                    
   · Protects and encourages explorers and independents                                                                         
The PPT  tax rate and  the tax credit  rates will be  proposed in                                                               
the near future.  General principle is that  the overall revenues                                                               
to the state  must be significantly higher at  today's prices. At                                                               
low  prices, the  state revenues  will be  less than  the current                                                               
system,  which  provides a  fair  adjustment  relative to  market                                                               
conditions. For  average prices,  companies making low  levels of                                                               
investment will  pay significantly more than  the current system,                                                               
while strong  investors will  pay an amount  that could  be less,                                                               
depending  on the  level  of  investment. If  the  price is  low,                                                               
Alaska shares the  burden, if the prices are  high; Alaska shares                                                               
the benefits with the oil producers.                                                                                            
3:47:47 PM                                                                                                                    
Also important to note is  that at average prices, companies that                                                               
make  low investments  will pay  significantly  more, but  strong                                                               
investments may pay less. It depends on how much they invest.                                                                   
The PPT  is a profit-based  system. There  are two ways  in which                                                               
profit-based systems  are implemented around the  world: Based on                                                               
taxation  systems paid  in cash,  or based  on production-sharing                                                               
systems. All the large oil  companies work in countries that have                                                               
this profit-based system so they are familiar with them.                                                                        
3:51:47 PM                                                                                                                    
The enhanced incentives to invest  in exploration and development                                                               
through the PPT as well as  the gas line investment will create a                                                               
new  environment  whereby  Alaska  will  be  considered  by  many                                                               
petroleum companies a new core  area for petroleum investment and                                                               
increased oil and gas production.                                                                                               
3:53:59 PM                                                                                                                    
Dr. van  Muers concluded his  presentation by saying  the current                                                               
ELF-based  production  tax  is   completely  outdated.  It  is  a                                                               
regressive  tax and  is  no  longer in  the  interest of  Alaska.                                                               
Therefore the Governor proposes  that Alaska adopt a profit-based                                                               
system  that will  provide  on average  for  a higher  government                                                               
take.  It  is a  progressive  tax  with  a strong  incentive  for                                                               
investment and exploration. It will  also attract new entrants to                                                               
the state.                                                                                                                      
3:54:32 PM                                                                                                                    
SENATOR WAGONER advised  Dr. van Muers that  the total production                                                               
in  Cook  Inlet  (16  platforms) is  between  24,000  and  26,000                                                               
barrels  per day.  He asked  how to  model the  PPT to  encourage                                                               
additional work in the aging fields.                                                                                            
DR. VAN  MUERS responded  that only a  few fields  pay production                                                               
tax in Cook Inlet  so the burden is modest. The  PPT will not put                                                               
a  stronger burden  on the  operators.  The PPT  will enable  the                                                               
producers  to take  a new  look  at the  oil and  gas fields  and                                                               
realize there are new opportunities  for investment through using                                                               
tax credits.                                                                                                                    
REPRESENTATIVE  GARDNER  asked  the  moment it  would  have  been                                                               
prudent to change the outdated ELF tax structure.                                                                               
DR. VAN MUERS  admitted when ELF was designed  it was innovative.                                                               
It is most important to note  that the current moment is the time                                                               
to change  the tax system.  The economic equation has  changed so                                                               
dramatically that Alaska must move to the PPT structure.                                                                        
3:59:44 PM                                                                                                                    
SENATOR STEDMAN  asked Dr. van  Muers whether the  current splits                                                               
between the  oil companies and the  governments were particularly                                                               
dynamic to the point where governments were modifying the PPT.                                                                  
DR. VAN MUERS responded there are  two things going on around the                                                               
world.  A  large  number  of  countries  have  relatively  strong                                                               
progressive systems. For example  Russia, Angola, Azerbaijan, and                                                               
areas where the major oil  companies have major investments. What                                                               
is  happening  today  as  result  of higher  oil  prices  is  the                                                               
progressive systems are  now clicking in and  the government take                                                               
is  going  up  significantly.  Many other  countries  today  have                                                               
adjusted their systems in view of  the higher oil prices. He said                                                               
everybody else is doing it and  that it is the international way.                                                               
If Alaska were  to put a similar system in  place it would remain                                                               
competitive with the other countries.                                                                                           
4:02:46 PM                                                                                                                    
SENATOR  DYSON  asked  whether  the  PPT  would  encourage  major                                                               
companies to invest  more here, and what would  happen to state's                                                               
take if oil prices decrease dramatically.                                                                                       
DR.  VAN MUERS  said the  major oil  companies are  significantly                                                               
investing in Alaska  and they would increase  that investment. If                                                               
oil prices went down, the PPT  would be down to zero. Implicit in                                                               
the PPT is if there are no profits, there are no taxes.                                                                         
4:05:30 PM                                                                                                                    
SENATOR DYSON  asked whether it was  fair to imply the  major oil                                                               
companies would support the PPT.                                                                                                
DR. VAN  MUERS admitted there was  no agreement at this  point in                                                               
time but discussions were being continued.                                                                                      
SENATOR  ELTON  asked  whether  the  proposal  was  going  to  be                                                               
presented to the  Legislature inside or outside  the gas pipeline                                                               
DR.  VAN MUERS  explained  it  would be  presented  as  a law  of                                                               
general application.                                                                                                            
4:08:26 PM                                                                                                                    
REPRESENTATIVE   RAMRAS  expressed   concern  over   creating  an                                                               
adversarial relationship with the  oil companies. He said British                                                               
Petroleum has taken punitive measures in the past with ELF.                                                                     
DR.  VAN  MUERS agreed.  He  said  the  PPT would  encourage  the                                                               
industry to  invest in Alaska  on a large scale.  Competition for                                                               
investment dollars is very strong around the world.                                                                             
4:12:20 PM                                                                                                                    
REPRESENTATIVE SEATON  asked whether trade-able credits  could be                                                               
applied against royalty payments,  corporate tax, production tax,                                                               
and property tax.                                                                                                               
DR. VAN MUERS said it could  be applied to the production tax. It                                                               
would  not be  creditable  against royalty  or  property tax.  It                                                               
could become creditable to the state corporate income tax.                                                                      
4:14:55 PM                                                                                                                    
REPRESENTATIVE  SEATON asked  whether the  Norway 78  percent tax                                                               
rate corresponded with Britain's 50 percent tax rate.                                                                           
DR. VAN MUERS  said no. Each nation has its  own government take.                                                               
Norway  has  been  traditionally  high  and  Britain  has  a  low                                                               
government  take.   Each  region   is  competitive  to   its  own                                                               
4:17:26 PM                                                                                                                    
REPRESENTATIVE  SEATON said  Britain has  recently increased  its                                                               
take 40-50  percent. He asked whether  that was a PPT  or a total                                                               
government take.                                                                                                                
DR. VAN MUERS  said it is a total government  take. Britain has a                                                               
low  government  take by  international  standards.  They have  a                                                               
corporate  income tax  of 30  percent and  also a  special surtax                                                               
that used to be 10 percent and is now 20 percent.                                                                               
(Representative Ethan Berkowitz joined the meeting.)                                                                            
SENATOR OLSON asked what system that Alberta (Canada) is using.                                                                 
DR. VAN  MUERS responded  they are  using many  different systems                                                               
and at several  stages. It is the same overall  philosophy as the                                                               
PPT just engineered differently.                                                                                                
4:20:11 PM                                                                                                                    
REPRESENTATIVE NEUMAN asked  at what point would  the state break                                                               
DR.  VAN MUERS  advised they  were  still working  on the  detail                                                               
figures but that it depends on  a number of different indices and                                                               
4:22:18 PM                                                                                                                    
SENATOR  FRENCH asked  whether the  administration  was going  to                                                               
file a bill.                                                                                                                    
DR. VAN MUERS replied yes.                                                                                                      
4:24:55 PM                                                                                                                    
REPRESENTATIVE  GARA  asked  the  level  at  which  Alaska  would                                                               
envision lowering taxes for the oil companies.                                                                                  
DR. VAN MUERS  advised he would have detailed  studies to present                                                               
with  the  final  proposal.  The  final  figures  are  not  fully                                                               
developed at this time.                                                                                                         
There being  no further  business to  come before  the committee,                                                               
Chair Wagoner adjourned the meeting at 4:28:06 PM.                                                                            

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