Legislature(2005 - 2006)BUTROVICH 205

02/23/2006 03:30 PM RESOURCES


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03:38:57 PM Start
03:51:35 PM SB305
06:21:47 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= SB 305 OIL AND GAS PRODUCTION TAX TELECONFERENCED
Heard & Held
Presentation by Administration
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                       February 23, 2006                                                                                        
                           3:38 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Thomas Wagoner, Chair                                                                                                   
Senator Ralph Seekins, Vice Chair                                                                                               
Senator Ben Stevens                                                                                                             
Senator Bert Stedman                                                                                                            
Senator Kim Elton                                                                                                               
Senator Albert Kookesh                                                                                                          
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Senator Fred Dyson                                                                                                              
                                                                                                                                
OTHER MEMBERS PRESENT                                                                                                         
                                                                                                                                
Senator Gretchen Guess                                                                                                          
Senator Gene Therriault                                                                                                         
Senator Hollis French                                                                                                           
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
SENATE BILL NO. 305                                                                                                             
"An Act repealing  the oil production tax and  gas production tax                                                               
and providing  for a production tax  on the net value  of oil and                                                               
gas; relating to the relationship  of the production tax to other                                                               
taxes; relating to the dates  tax payments and surcharges are due                                                               
under AS  43.55; relating  to interest  on overpayments  under AS                                                               
43.55; relating  to the treatment  of oil and gas  production tax                                                               
in a  producer's settlement with  the royalty owner;  relating to                                                               
flared gas, and to  oil and gas used in the  operation of a lease                                                               
or property, under AS 43.55;  relating to the prevailing value of                                                               
oil or gas under AS 43.55;  providing for tax credits against the                                                               
tax  due under  AS 43.55  for certain  expenditures, losses,  and                                                               
surcharges; relating to statements  or other information required                                                               
to be filed  with or furnished to the Department  of Revenue, and                                                               
relating  to the  penalty for  failure to  file certain  reports,                                                               
under  AS 43.55;  relating to  the  powers of  the Department  of                                                               
Revenue, and  to the disclosure  of certain  information required                                                               
to be  furnished to  the Department of  Revenue, under  AS 43.55;                                                               
relating   to  criminal   penalties   for  violating   conditions                                                               
governing access to and use  of confidential information relating                                                               
to the  oil and gas  production tax;  relating to the  deposit of                                                               
money  collected by  the Department  of Revenue  under AS  43.55;                                                               
relating to  the calculation of the  gross value at the  point of                                                               
production of  oil or gas;  relating to the determination  of the                                                               
net value  of taxable oil  and gas  for purposes of  a production                                                               
tax on the net value of  oil and gas; relating to the definitions                                                               
of  'gas,' 'oil,'  and certain  other  terms for  purposes of  AS                                                               
43.55;  making  conforming  amendments;   and  providing  for  an                                                               
effective date."                                                                                                                
     HEARD AND HELD                                                                                                             
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: SB 305                                                                                                                  
SHORT TITLE: OIL AND GAS PRODUCTION TAX                                                                                         
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
                                                                                                                                
02/21/06       (S)       READ THE FIRST TIME - REFERRALS                                                                        
02/21/06       (S)       RES, FIN                                                                                               
02/22/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/22/06       (S)       Heard & Held                                                                                           
02/22/06       (S)       MINUTE(RES)                                                                                            
02/23/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                              
DR. PEDRO VAN MEURS, Oil and Gas Consultant to the Governor                                                                     
Van Meurs and Associates Ltd.                                                                                                   
Calgary, Alberta, Canada                                                                                                        
POSITION  STATEMENT:   Delivered  PowerPoint  slide  show on  the                                                               
Petroleum Profits Tax (PPT"                                                                                                     
                                                                                                                                
ROGER MARKS, Petroleum Economist                                                                                                
Department of Revenue                                                                                                           
PO Box 110400                                                                                                                   
Juneau, AK  99811-0400                                                                                                          
POSITION   STATEMENT:  Delivered   the   "PPT  Revenue   Studies"                                                             
PowerPoint presentation for the Department of Revenue                                                                           
                                                                                                                                
ROBYNN WILSON, Director                                                                                                         
Anchorage Office                                                                                                                
Tax Division                                                                                                                    
Department of Revenue                                                                                                           
PO Box 110400                                                                                                                   
Juneau, AK  99811-0400                                                                                                          
POSITION STATEMENT: Commented on SB 305                                                                                       
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
CHAIR  THOMAS  WAGONER  called   the  Senate  Resources  Standing                                                             
Committee meeting to  order at 3:38:57 PM.  Present were Senators                                                             
Ben Stevens, Bert  Stedman, Ralph Seekins, Al  Kookesh, Kim Elton                                                               
and Chair Thomas Wagoner. Senators  Gretchen Guess, Hollis French                                                               
and Gene Therriault also attended the meeting.                                                                                  
                                                                                                                                
               SB 305-OIL AND GAS PRODUCTION TAX                                                                            
                                                                                                                              
CHAIR   Thomas  WAGONER   announced   SB  305   to   be  up   for                                                               
consideration. He asked Dr. Van Meurs to proceed.                                                                               
                                                                                                                                
DR.  PEDRO VAN  MEURS, Oil  and Gas  Consultant to  the Governor,                                                               
introduced the  February 23, 2006 PowerPoint  presentation titled                                                               
"Petroleum Production Tax".                                                                                                     
                                                                                                                                
Slide 2  demonstrates that  the Alaska  fiscal system  applied to                                                               
oil  and  gas consists  of  four  primary components:  royalties,                                                               
production tax  (severance tax, "ELF"),  property tax,  and state                                                               
corporate income tax.  In addition, there is  a federal corporate                                                               
income tax.                                                                                                                     
                                                                                                                                
The  presentation   relates  to  the   international  competitive                                                               
aspects of  the proposed petroleum production  tax. Obviously, he                                                               
said, when international fiscal  system comparisons are done, the                                                               
entire state and federal package is compared together.                                                                          
                                                                                                                                
Slide  3  provides  an  explanation  of  the  PPT.  The  proposal                                                               
outlined in  SB 305  calls for  a 20  percent tax  rate and  a 20                                                               
percent tax credit rate, a  $73 million tax-free allowance, and a                                                               
capital expenditure  (capex) clawback  over the last  five years.                                                               
Capex includes all expenditures  related to wells, facilities and                                                               
such.                                                                                                                           
                                                                                                                                
Slide 4 outlines the history  of the project, which was finalized                                                               
on   February   14,   2006.  Until   early   January   2006   his                                                               
recommendation was  for a  20 percent  tax and  a 15  percent tax                                                               
credit based  on the international competitiveness  analysis, but                                                               
as the  results became known,  he decided to  amend that to  a 25                                                               
percent tax  rate and a 20  percent tax credit rate  (25/20). Due                                                               
to that change,  the report contains reference to  both 20/15 and                                                               
25/20.                                                                                                                          
                                                                                                                                
The 20/20  concept and  the capex  clawback were  suggested after                                                               
the  report was  finalized so  reference to  that system,  as the                                                               
main  feature in  the report  won't  be found.  However, Dr.  Van                                                               
Meurs    said,   from    the    perspective   of    international                                                               
competitiveness,  the   options  are   similar  so   the  general                                                               
conclusions of the report remain valid for the 20/20 concept.                                                                   
                                                                                                                                
Slide 5 is the table of contents.                                                                                               
     Executive Summary                                                                                                          
        1. Introduction                                                                                                         
        2. New international trends in government take                                                                          
        3. Economic analysis                                                                                                    
        4. Analysis of the 20/15 PPT                                                                                            
        5. Analysis of alternative PPTs                                                                                         
        6. International competitiveness of the 20/15 PPT                                                                       
        7. International rating of the 20/15 PPT                                                                                
        8. Competitiveness and PPT rate                                                                                         
        9. International rating of the 25/20 PPT                                                                                
        10.    Heavy Oil Incentives                                                                                             
        11.    Review of 25/20 PPT                                                                                              
                                                                                                                                
The table  in Slide 6 considers  the range of cost  scenarios for                                                               
different  field sizes.  For this  kind of  fiscal analysis  it's                                                               
important  to consider  a  wide  range of  cost  and field  sizes                                                               
because you  don't know what size  the next find will  be. If the                                                               
Artic  National  Wildlife  Refuge  (ANWR)  is  ever  opened  it's                                                               
important to  have an  adequate fiscal analysis  in place  so the                                                               
state  can receive  maximum  benefit. That  being  said, Dr.  Van                                                               
Meurs explained that  the main focus of the economic  work was on                                                               
high cost  fields of  50 million and  150 million  barrels, since                                                               
those field types represent North Slope conditions.                                                                             
                                                                                                                                
Slide 7 analyzes  the 20/20 PPT when oil is  $40. The chart shows                                                               
the  royalties,  PPT,  property  taxes,  and  state  and  federal                                                               
corporate income taxes  for "DRY HOLE," 50 MM, 150  MM and 500 MM                                                               
barrel fields.                                                                                                                  
                                                                                                                                
When you  examine a  DRY HOLE  you see  the numbers  are negative                                                               
meaning the amounts  are deductible for PPT  purposes because the                                                               
PPT is now on a corporate  basis. Looking at how much is returned                                                               
from the government  as a result of lower PPT  or lower corporate                                                               
income tax,  you can see that,  for $40 oil, 64.7  percent of the                                                               
well cost is returned to the  investor. The DRY HOLE data clearly                                                               
shows  that  the  PPT  is an  enormously  strong  instrument  for                                                               
exploring or drilling other wells.                                                                                              
                                                                                                                                
The next three columns show 50 MM,  150 MM and 500 MM. For the 50                                                               
MM field  the PPT is  -110.1. That  means that for  new investors                                                               
the $73 million  tax-free allowance applies so  for all practical                                                               
purposes the  investor won't  pay the tax,  but will  receive the                                                               
tax credits. For the larger  fields the tax rapidly overcomes the                                                               
tax credits  and a  lot of  PPT is  payable. If  you look  at the                                                               
overall "Alaska government take," you see  that for a small 50 MM                                                               
field it is 22.6  percent and that goes up to  35.4 percent for a                                                               
500  MM field.  The  "Federal government  take  ranges from  27.2                                                               
percent  for the  50 MM  field  to 22.7  percent for  the 500  MM                                                               
field.                                                                                                                          
                                                                                                                                
3:51:35 PM                                                                                                                    
                                                                                                                                
Slide  8 illustrates  that tax  credits are  important for  small                                                               
fields and that  they have considerable impact  on the break-even                                                               
point.  The  chart is  a  sensitivity  analysis  for PPTs  of  20                                                               
percent with  no tax credit,  a 15 percent  tax credit, and  a 25                                                               
percent  tax  credit.  The  break-even point  is  about  $22  per                                                               
barrel, but with a 25 percent tax  credit it rises to as much $34                                                               
per barrel. The higher the  tax credit, the higher the break-even                                                               
price, he said.                                                                                                                 
                                                                                                                                
He made the point that the  tax credits make for a riskier system                                                               
for  the state.  The more  tax  credits, the  greater the  chance                                                               
there  are  negative  values  for  fields.  That  emphasizes  the                                                               
importance of  striking the right  balance between tax  rates and                                                               
tax  credits.   He  reminded  members  that   he  had  previously                                                               
recommended   the   20/15   combination  and   then   the   25/20                                                               
combination. He  favors combinations in  which the tax  rates are                                                               
combined with a somewhat lower tax credit rate.                                                                                 
                                                                                                                                
Overall, the  20/20 combination is  a riskier system  than either                                                               
20/15 or 25/20.  The graph clearly demonstrates  that tax credits                                                               
have an enormous impact on the crossover point.                                                                                 
                                                                                                                                
Slide 9 shows  the internal rate of return (IRR)  for 150 million                                                               
barrel fields  under low  well productivity  and high  costs. The                                                               
higher the tax  credits the higher the rate of  return. The chart                                                               
shows  that with  a 25  percent tax  credit rate  the IRR  can be                                                               
increased by as much as 5  percentage points for this size field.                                                               
Clearly, the  tax credits are  the main instrument  for improving                                                               
the  IRR,  which is  an  important  factor  in making  these  tax                                                               
payments so attractive for new investors.                                                                                       
                                                                                                                                
3:55:16 PM                                                                                                                    
Slide 10 makes the following  statement: The competitive position                                                               
of the  Alaska system  was analyzed using  the same  field sizes.                                                               
Eight fiscal systems were analyzed  and they all reflect areas in                                                               
the  world  where  considerable investment  is  currently  taking                                                               
place. Those systems include: Norway,  UK, US Gulf Coast, Alberta                                                               
Oil Sands, Nigeria, Angola, Russia-Sakhalin, and Azerbaijan.                                                                    
                                                                                                                                
3:56:20 PM                                                                                                                    
Slide  11  establishes  the  principle  that  relative  to  other                                                               
jurisdictions, Alaska  has the disadvantage  of a  relatively low                                                               
wellhead  value due  to  high transportation  costs  and a  lower                                                               
quality than other  crude in the world. As a  result of those two                                                               
factors,  there is  a $7  differential  between a  barrel of  oil                                                               
produced in  the Gulf of Mexico  and a barrel of  oil produced on                                                               
the  North  Slope. The  study  takes  that $7  differential  into                                                               
consideration  so if  the rate  of  return for  Alaska and  other                                                               
jurisdictions is the same, it  means that it's already taken into                                                               
account that the  Alaska wellhead price is $7 less  than the Gulf                                                               
of Mexico or $5 less than Alberta.                                                                                              
                                                                                                                                
The  slide indicates  that  many nations  have  a lower  wellhead                                                               
price than the Gulf of Mexico.  For instance, Azerbaijan has a $6                                                               
differential. Dr.  Van Meurs advised that  he included Azerbaijan                                                               
to  make a  comparative analysis  between jurisdictions  with low                                                               
net back values or low wellhead prices.                                                                                         
                                                                                                                                
DR. VAN MEURS explained that the  next few slides show the actual                                                               
international comparison  of different  fiscal systems  that were                                                               
studied.                                                                                                                        
                                                                                                                                
The graph in slide 12 shows the  rate of return for a 500 million                                                               
barrel field in Norway and  the United Kingdom. The British terms                                                               
are very  profitable and  the Norwegian  terms are  somewhat less                                                               
profitable. All the  PPTs fall between the  British and Norwegian                                                               
terms.                                                                                                                          
                                                                                                                                
4:00:19 PM                                                                                                                    
Slide  13 illustrates  the IRR  for a  50 MM  barrel field  for a                                                               
first investment.  The new  investor would  benefit from  the $73                                                               
million tax-free allowance. They wouldn't  pay any PPT tax on the                                                               
first discovery,  but they  would still  receive the  tax credit.                                                               
The graph  clearly demonstrates that by  international standards,                                                               
the first  field would be  very profitable. Once the  price rises                                                               
to $30 or $40 per barrel it  doesn't matter much whether a PPT of                                                               
20/20 or  25/20 or  20/15 is  selected, all have  a high  rate of                                                               
return. That's because the tax isn't  paid, but the tax credit is                                                               
received so there's actually a negative PPT.                                                                                    
                                                                                                                                
Slide  14  shows   the  average  government  take   for  a  first                                                               
investment  in  a  large  500  MM  barrel  field.  The  worldwide                                                               
spectrum of government  take is represented here  with the United                                                               
Kingdom government take  at 50 percent and  the Norway government                                                               
take at  78 percent. The government  take for Alaska is  about 60                                                               
percent for  each of the  various fiscal options.  The government                                                               
take includes  the federal  corporate income  tax in  addition to                                                               
royalties, property  tax, and the  state corporate income  tax so                                                               
the PPT  is just a  small component.  The options all  have about                                                               
the same take, but  when you move from 20/20 to  25/20 there is a                                                               
one  or   two  percentage  point  increase   in  government  take                                                               
depending on price and cost levels.                                                                                             
                                                                                                                                
Slide  15 illustrates  the average  government take  for a  first                                                               
investment  in  a  50  MM  barrel field.  In  this  scenario  the                                                               
government  take  averages about  50  percent,  but at  very  low                                                               
prices it feathers off to the  point of being uneconomic. That is                                                               
in contrast  to the last slide  showing that a large  field has a                                                               
60 percent government take.                                                                                                     
                                                                                                                                
Slide 16 deals with the  competitive index covered in chapters 7,                                                               
8, and 9 of the report,  which shows how competitive a system is.                                                               
Dr.  Van  Meurs  explained  that the  methodology  is  relatively                                                               
simple. Collect a number of  economic variables including rate of                                                               
return, net  present value, and  government take for a  number of                                                               
different  field sizes  and  cost conditions.  In  the study,  48                                                               
elements were  evaluated for  10 different  fiscal systems.  If a                                                               
fiscal system was  the best in all 48 elements,  then a rating of                                                               
48 was  given. The  fiscal system  that was the  worst of  10 was                                                               
given a rating of 480.                                                                                                          
                                                                                                                                
4:05:39 PM                                                                                                                    
Slide  17 shows  new investor  ratings for  a 20/15  and a  25/20                                                               
system. The US  Gulf of Mexico with  a score of 52  is best under                                                               
the 20/15  rating while the  Russia-Sakhalin score of 444  is the                                                               
worst. The  score for the  Alaska Current  system is 364  and the                                                               
Alaska PPT  score is 272.  That means  that a new  investor would                                                               
perceive  the  PPT as  significantly  more  competitive than  the                                                               
Alaska  Current  system. He  noted  that  even though  he  hadn't                                                               
evaluated  the  20/20  system  the   same  would  hold  for  that                                                               
combination and certainly it would  be more attractive to the new                                                               
investor than the Alaska Current system.                                                                                        
                                                                                                                                
Slide 18  relates to PPT  and heavy  oil. Heavy oil  represents a                                                               
new  generation  of oil  in  Alaska  and it's  important  because                                                               
there's an  estimated 3 to 5  billion barrels of it  on the North                                                               
Slope. At this  point not much is in production,  but the idea is                                                               
that PPT would also stimulate production of heavy oil.                                                                          
                                                                                                                                
The  slide illustrates  the  importance of  the  tax credits  for                                                               
heavy oil because  it is a very  capital-intensive operation. The                                                               
25/20  system  and  the  higher  tax  credit  rates  show  little                                                               
difference, which is an important  element in the conclusion that                                                               
a 20  percent tax credit seems  to be adequate to  boost the rate                                                               
of return  for heavy  oil by  approximately 5  percentage points.                                                               
That means a 25 percent tax credit isn't necessary.                                                                             
                                                                                                                                
4:08:30 PM                                                                                                                    
Slide  19  concludes that  the  20/20  proposal results  in  very                                                               
competitive  terms  for  new  investors  and  existing  petroleum                                                               
companies when analyzed from an international perspective.                                                                      
                                                                                                                                
It  continues  with the  following  statement:  "The system  will                                                               
therefore result in more investment  in Alaska, while at the same                                                               
time  creating  much  higher revenues,  primarily  from  existing                                                               
production  and  under average  and  high  prices also  from  new                                                               
production."                                                                                                                    
                                                                                                                                
4:10:14 PM                                                                                                                    
SENATOR  STEDMAN asked  how  old the  data is  on  slide 17  that                                                               
compares   various   international   regimes.  He   related   his                                                               
impression that  what is currently  taking place in  Alaska today                                                               
has been  taking place  in other  countries for  the last  two or                                                               
three years.                                                                                                                    
                                                                                                                                
DR. VAN MEURS  replied the fiscal terms on slide  17 are based on                                                               
the situation  today and  take into  consideration the  fact that                                                               
some  nations  have  already  increased  the  fiscal  terms.  For                                                               
example, the United Kingdom is rated  based on the change made in                                                               
December  2005  when it  raised  the  overall  tax rate  from  40                                                               
percent to 50  percent. Similarly, the information  for Norway is                                                               
based  on the  latest  version of  the  Norwegian fiscal  system,                                                               
which was revised last year.                                                                                                    
                                                                                                                                
DR.  VAN MEURS  related that  Chapter 2  of his  report questions                                                               
whether or not the world  is under upward pressure for government                                                               
take.  The answer,  he said,  is absolutely.  That trend  is very                                                               
strong in this "new world." Until  a few years ago the government                                                               
take was sliding down, now the process has reversed.                                                                            
                                                                                                                                
4:13:39 PM                                                                                                                    
SENATOR ELTON referenced  the 25/20 rating on slide  17 and asked                                                               
if the scoring system reflects just the government take.                                                                        
                                                                                                                                
DR.  VAN  MEURS  said  no,  scoring is  based  on  four  economic                                                               
indicators: rate of return, net  present value, expected monetary                                                               
value, and  government take.  Those variables  are applied  to 12                                                               
different  field/cost/revenue  configurations  to create  the  48                                                               
element system. Investors  like a high rate of return  with a low                                                               
government  take so  if a  system scores  1 it  means it  has the                                                               
lowest government  take with  the highest rate  of return  on the                                                               
present value.                                                                                                                  
                                                                                                                                
SENATOR ELTON  offered the  view that  investors would  also look                                                               
for  stability.  Given current  events  and  what's happening  in                                                               
regimes around the world he  surmised that Nigeria might be rated                                                               
artificially high.                                                                                                              
                                                                                                                                
DR. VAN MEURS agreed then reiterated  the point that this is just                                                               
a  fiscal rating  for  giving a  general  impression of  improved                                                               
competitiveness. He observed  that, in general, the  quality of a                                                               
resource  base  is  inversely proportional  to  the  rating.  The                                                               
countries with the  best ratings are places that have  no oil and                                                               
gas at all  while the worst ratings are in  the Middle East where                                                               
large  low-cost  oil reserves  are  found.  He acknowledged  that                                                               
apart from the  fiscal elements on the chart,  many other factors                                                               
figure into an investor's decision.                                                                                             
                                                                                                                                
SENATOR  ELTON suggested  that  because  political stability  and                                                               
fiscal  stability  are  such  major issues,  a  tax  premium  for                                                               
factors that aren't  reflected in the chart on slide  17 might be                                                               
in order.                                                                                                                       
                                                                                                                                
DR. VAN  MEURS responded there  are firms whose core  business is                                                               
doing different kinds of risk  evaluations. His rating relates to                                                               
the fiscal terms and doesn't address overall attractiveness.                                                                    
                                                                                                                                
4:19:54 PM                                                                                                                    
SENATOR BERT STEDMAN noted that  on page 126 the report discusses                                                               
the  25/20 system  and in  the  overall rating  section it  talks                                                               
about  25/20 being  more attractive  to new  and small  investors                                                               
than the 20/15 system.                                                                                                          
                                                                                                                                
DR. VAN MEURS explained that the  reason is that within a certain                                                               
range the  tax credit  rate is actually  more important  than the                                                               
tax rate  itself. He added  he's confident the 20/20  system will                                                               
rate very well.                                                                                                                 
                                                                                                                                
SENATOR STEDMAN  noted that  the chapter  conclusion says  "If it                                                               
can be concluded that the 20  percent tax rate and the 20 percent                                                               
credit  would  be competitive  from  the  international point  of                                                               
view, and the  overall government take would be  similar to other                                                               
countries that  have equal or lesser  resource quality, therefore                                                               
it is  a fair and reasonable  system." He asked why  one tax rate                                                               
would be better than the other.                                                                                                 
                                                                                                                                
DR. VAN MEURS replied his  recommendation for the 25/20 system as                                                               
well as the work done by  Mr. Marks and the Department of Revenue                                                               
clearly  indicated   that  the  25/20  system   results  in  more                                                               
revenues.   The  Governor   has  to   take  other   factors  into                                                               
consideration and he  settled on the 20/20  system. However, when                                                               
you look  at all the  various systems, the government  take isn't                                                               
that different because the tax component  is just one of a number                                                               
of other components.  He reminded members that he  told the joint                                                               
body that  a 20 percent  or higher tax and  15 or 20  percent tax                                                               
credit are  all competitive systems.  Basically, all  the systems                                                               
in the range  could be recommended, but when the  tax rises to 30                                                               
percent then you  start to lose competitiveness.  His report also                                                               
indicated that a tax rate of 10  or 15 percent is too low and not                                                               
in the best interest of the state.                                                                                              
                                                                                                                                
4:25:05 PM                                                                                                                    
CHAIR  WAGONER  asked  by what  percentage  the  government  take                                                               
differs between the 20/20 system and the 20/25 system.                                                                          
                                                                                                                                
DR.  VAN  MEURS  replied  the   overall  difference  is  about  2                                                               
percentage  points,  but in  terms  of  money the  difference  is                                                               
relatively  large. According  to Mr.  Mark's graph  for $40  oil,                                                               
there's about $300 million difference  per year between 25/20 and                                                               
20/20.                                                                                                                          
                                                                                                                                
4:26:17 PM                                                                                                                    
SENATOR  HOLLIS FRENCH  asked  Dr. Van  Meurs  to articulate  and                                                               
quantify the increased  risk in the 20/20 system  compared to the                                                               
25/20 system.                                                                                                                   
                                                                                                                                
DR. VAN  MEURS responded it's always  a good idea to  look at the                                                               
risk in  addition to the  revenues. He clarified that  he defines                                                               
risk from a  fiscal standpoint so the evaluation  relates to what                                                               
happens at  low oil prices. The  PPT is a profit-based  system so                                                               
if prices  are low, you're  worse off  than with the  current tax                                                               
system. The higher the tax credits  relative to the tax rate, the                                                               
greater the  risk because  with down-side  prices you  have large                                                               
tax credits  that could be  transferred to other  companies. That                                                               
would result  in a  significant reduction of  the PPT.  If prices                                                               
are up and the tax rate  is lower, you wouldn't collect much more                                                               
than if the  tax rate were higher. That's why,  from a risk point                                                               
of view, 20/15  and 25/20 are the two best  combinations; the tax                                                               
rates are higher  than the tax credit rate. When  prices are high                                                               
the gains  are greater than the  credits that may be  lost on the                                                               
down side.                                                                                                                      
                                                                                                                                
4:28:51 PM                                                                                                                    
CHAIR  WAGONER  asked  Dr.  Van  Meurs  to  provide  figures  for                                                               
government  take for  the proposed  system as  well as  5 and  10                                                               
percent peer group discounts.                                                                                                   
                                                                                                                                
DR. VAN MEURS  agreed to do so and continued  to explain that the                                                               
competitiveness  position changes  depending  on discount  rates.                                                               
With discount  rates the Alaska  Current system tends to  drop in                                                               
competitiveness, the PPT  stays the same relative  to others, and                                                               
back-end loaded systems improve.                                                                                                
                                                                                                                                
4:31:50 PM                                                                                                                    
SENATOR  GENE  THERRIAULT  referenced data  from  Alberta  Canada                                                               
relating to  government take. The  information indicates  that on                                                               
the  down side  government take  is  up to  80 percent  due to  a                                                               
royalty system  that is  somewhat regressive  at low  prices. For                                                               
mid range the  government take is about 70 percent  and on the up                                                               
side the government take is 65  percent. He noted that page 15 of                                                               
the report says  that on a $50  MM barrel field as  price goes up                                                               
the  government take  rises to  about 50  percent and  for larger                                                               
fields  overall government  take rises  to about  60 percent.  He                                                               
asked why it's still lower than  what Alberta receives and what a                                                               
fair overall government take might be                                                                                           
                                                                                                                                
MR. VAN MEURS  replied Alberta doesn't have a  low wellhead value                                                               
like  Alaska does  so,  on  average, it  is  $5  better off  than                                                               
Alaska.  In other  words, depending  on cost  conditions, if  the                                                               
government take were the same, the  rate of return or net present                                                               
value  in Alberta  would  still  be higher  than  in Alaska.  The                                                               
difference is due to transportation costs.                                                                                      
                                                                                                                                
SENATOR  STEDMAN  referenced table  9.19  of  the report  showing                                                               
percentage  of  government  take  and   asked  if  he  should  be                                                               
concerned that government take drops as price rises.                                                                            
                                                                                                                                
DR.  VAN  MEURS  replied  not necessarily.  The  purpose  of  the                                                               
tidewater analysis was to illustrate  what Alaska resources would                                                               
look like  if they were in  Texas. The $5 transportation  fee was                                                               
changed to a 12.5 percent royalty, which is a regressive system.                                                                
                                                                                                                                
Other  consultants   were  comfortable  using  the   figures  for                                                               
comparative purposes. They show  that overall government take for                                                               
20/15 or 25/20 is within the range of reason.                                                                                   
                                                                                                                                
4:38:42 PM                                                                                                                    
SENATOR  THERRIAULT asked  how  many international  jurisdictions                                                               
are modifying their tax systems.                                                                                                
                                                                                                                                
DR. VAN MEURS explained that  progressive nations are changing to                                                               
a system in which the  government take goes up automatically. His                                                               
perception is that  there is clear upward  pressure on government                                                               
take  for  oil  so  Alaska   is  well  within  the  international                                                               
framework.  He added  that  isn't necessarily  the  case for  gas                                                               
because there is still a lot of stranded gas available.                                                                         
                                                                                                                                
4:41:51 PM                                                                                                                    
SENATOR   THERRIAULT  asked   if  the   20/20  system   would  be                                                               
destabilizing  if the  price  of oil  were to  rise  to $200  per                                                               
barrel in  the next  five years because  the state's  share would                                                               
drop at very high prices.                                                                                                       
                                                                                                                                
DR. VAN MEURS replied the  typical government take with the lower                                                               
netback  has   slight  progressivity,  but  there   isn't  strong                                                               
progressivity in  the overall system  as proposed. The  reason is                                                               
that  the highly  regressive royalty  and  the highly  regressive                                                               
property  tax  are  canceled  by   the  progressive  PPT  thereby                                                               
creating a neutral system.                                                                                                      
                                                                                                                                
He noted that  there are more progressive  systems, but investors                                                               
look at the  entire range of prices and perceive  more up side if                                                               
there  isn't  as  much progressivity.  If  you  have  progressive                                                               
systems you typically  pay the price on the down  side. The focus                                                               
of the Alaska proposal is  to make sure that Alaska significantly                                                               
improves its income on average.                                                                                                 
                                                                                                                                
4:46:11 PM                                                                                                                    
SENATOR THERRIAULT asked  if any country has a  system that's the                                                               
same as the current proposal.                                                                                                   
                                                                                                                                
DR. VAN MEURS  said no, but the Norwegian system  is most similar                                                               
to  the PPT.  The  primary  difference between  the  two is  that                                                               
Alaska has  tax credits  and the  Norwegian system  uses uplifts,                                                               
which are extra cost allowances.  Tax credits are more attractive                                                               
to small investors because they can be sold the following year.                                                                 
                                                                                                                                
4:48:06 PM                                                                                                                    
SENATOR  BEN STEVENS  read the  last sentence  from slide  10 and                                                               
asked  Dr. Van  Meurs if  he considers  Alaska to  be a  place in                                                               
which "considerable investment is taking place.                                                                                 
                                                                                                                                
DR. VAN MEURS  replied he wouldn't say it's  considerable, but he                                                               
wouldn't qualify it as small  either. The large oil companies are                                                               
certainly doing  interesting things on  the North Slope,  but not                                                               
on  the level  that  Alaska needs  to avoid  the  decline of  oil                                                               
production.  Alaska  would like  a  higher  level of  investment,                                                               
which is why the PPT is designed the way it is.                                                                                 
                                                                                                                                
SENATOR  BEN  STEVENS asked  if  the  comparison relates  to  the                                                               
fiscal terms on oil alone or oil and gas.                                                                                       
                                                                                                                                
DR.  VAN MEURS  clarified the  comparison  is only  for oil.  The                                                               
stranded  gas contract  is based  on the  concept that  the state                                                               
would  take  royalty  and  tax  gas in  kind,  which  involves  a                                                               
completely  different  set  of  circumstances.  However,  if  the                                                               
stranded gas contract  does not come through, then  the PPT would                                                               
apply to  gas, which would raise  the question of whether  or not                                                               
the PPT is a competitive framework for gas as well.                                                                             
                                                                                                                                
4:53:46 PM                                                                                                                    
SENATOR  BEN  STEVENS referred  to  the  comparisons between  the                                                               
Alaska  production mechanisms  and those  in other  countries and                                                               
asked how many  of those countries re-inject their  gas, how many                                                               
flare their gas and how many take their gas to market.                                                                          
                                                                                                                                
DR. VAN  MEURS replied  it's different  from country  to country.                                                               
Norway has  large gas  fields that are  already developed  and it                                                               
has  very  large  export  lines.   The  United  Kingdom  actively                                                               
develops and uses its gas.  In Nigeria significant flaring of gas                                                               
is  occurring so  few  projects are  being  done. The  government                                                               
recognizes that  the flaring must stop  for obvious environmental                                                               
reasons  and companies  are  in  the process  of  putting in  re-                                                               
injection  schemes. Angola  already has  significant re-injection                                                               
of gas, but the market  is small. Russia-Sakhalin has always been                                                               
a joint  oil and  gas development scheme.  Azerbaijan is  not gas                                                               
prone, but it is  in the process of twinning its  oil line with a                                                               
gas line to supply gas to  Georgia and Turkey. That export scheme                                                               
is modest.                                                                                                                      
                                                                                                                                
SENATOR  BEN STEVENS  said his  point is  that each  country that                                                               
Alaska is analyzed with has  different economics in its petroleum                                                               
industry,  which is  why  he is  suspect  of blanket  comparisons                                                               
between Alaska and other international jurisdictions.                                                                           
                                                                                                                                
DR.  VAN MEURS  agreed and  reiterated the  fiscal comparison  is                                                               
just  one  of the  components.  Just  because a  system  compares                                                               
favorably from a fiscal point  doesn't mean that investors should                                                               
invest.  Investors must  also factor  the resource  base and  the                                                               
economic and political risks. Under  no circumstance would he say                                                               
that  the  fiscal comparison  would  stand  alone in  determining                                                               
whether or not a company should invest.                                                                                         
                                                                                                                                
4:59:41 PM                                                                                                                    
SENATOR STEDMAN asked how the  $73 million tax-free allowance was                                                               
determined.                                                                                                                     
                                                                                                                                
DR. VAN  MEURS explained that  he ran  cases for $50  million and                                                               
$100 million and  the fiscal terms wouldn't change  much. The $73                                                               
million figure  comes from  allocating $200,000  per day  for 365                                                               
days.  That calculation  is convenient  if  tax is  figured on  a                                                               
monthly basis.                                                                                                                  
                                                                                                                                
SENATOR STEDMAN remarked it could  amount to a substantial amount                                                               
of  revenue  if   a  large  number  of   small  companies  became                                                               
investors. He  said he'd think  about that over the  next several                                                               
days.                                                                                                                           
                                                                                                                                
DR. VAN MEURS responded it's  true smaller companies will come to                                                               
Alaska, but that  isn't cause for concern. He  suggested it would                                                               
be a good idea if more  small companies invested in the Fairbanks                                                               
region  or Cook  Inlet. Those  fields are  marginal so  the state                                                               
shouldn't be  concerned about the  tax because  economic activity                                                               
and  employment is  created. In  contrast, the  North Slope  will                                                               
attract more large companies. Furthermore,  the bill has specific                                                               
anti-splitting provisions to  discourage companies from splitting                                                               
up solely for the purpose of paying less tax.                                                                                   
                                                                                                                                
Alberta has  worked with a  similar system for decades  and found                                                               
it  to  be  quite  successful.  Small  companies  receive  fiscal                                                               
incentives  and  create niches  for  themselves  going after  the                                                               
marginal  conventional  oil  wells   while  the  large  companies                                                               
develop  the  oil  sands  and   heavy  oils.  He  suggested  that                                                               
something similar would probably evolve in Alaska.                                                                              
                                                                                                                                
5:06:24 PM                                                                                                                    
CHAIR  WAGONER  asked if  a  company  operating under  the  20/20                                                               
system could sell its credit.                                                                                                   
                                                                                                                                
DR. VAN MEURS  replied definitely; that's what  makes this fiscal                                                               
system  so attractive.  For  example  if a  new  company came  to                                                               
Alaska  to drill  near  Fairbanks,  it would  have  little or  no                                                               
income.  Because it  has the  $73 million  tax-free allowance  it                                                               
wouldn't pay  the PPT. However,  the investment would  create the                                                               
tax   credits   so   the    company's   position   has   improved                                                               
significantly. It  has the  tax credits, but  it doesn't  pay the                                                               
tax. That,  he said,  it about the  strongest stimulus  you could                                                               
give to encourage new investors  to come to Alaska. The incentive                                                               
is the  same for small  and large  investors, but once  a company                                                               
makes  a  significant  discovery, the  next  investment  wouldn't                                                               
benefit. The goal is to attract new companies.                                                                                  
                                                                                                                                
5:08:46 PM                                                                                                                    
SENATOR  ELTON questioned  the "shotgun"  approach and  asked why                                                               
the state  wouldn't target companies  coming in and  investing in                                                               
frontier  areas or  in heavy  oil.  He questioned  why the  state                                                               
should give a $73 million credit to Exxon.                                                                                      
                                                                                                                                
DR. VAN  MEURS agreed that  the $73 million credit  is applicable                                                               
to all  companies regardless of  size, but targeting makes  for a                                                               
more  complicated  system,  which   is  a  disincentive  from  an                                                               
investment  standpoint. The  goal is  to balance  simplicity with                                                               
effectiveness.                                                                                                                  
                                                                                                                                
5:12:02 PM                                                                                                                    
CHAIR  WAGONER acknowledged  the  explanation, but  if every  oil                                                               
company in Alaska receives a  $73 million discount every year for                                                               
20 years that  would amount to $4,380,000,000 for  just the three                                                               
major companies.                                                                                                                
                                                                                                                                
DR.VAN  MEURS clarified  the  $73 million  is  only the  tax-free                                                               
income.                                                                                                                         
                                                                                                                                
CHAIR WAGONER said  he didn't see the  correlation between trying                                                               
to  attract  new  exploration  and   granting  this  to  existing                                                               
companies.  Furthermore   he  didn't  believe  the   three  major                                                               
companies are  the only ones  that top  out over the  $73 million                                                               
per year.                                                                                                                       
                                                                                                                                
DR.VAN MEURS  responded he'd defer  to Mr. Marks, but  that's why                                                               
the assumption is for more.                                                                                                     
                                                                                                                                
5:14:03 PM                                                                                                                    
SENATOR  THERRIAULT asked  if there  are many  jurisdictions that                                                               
offer   the  certainty   that  modifications   are  out   of  the                                                               
government's reach.                                                                                                             
                                                                                                                                
DR.  VAN  MEURS  replied  about eight  nations  provide  absolute                                                               
fiscal stability and  about ten nations provide a  high degree of                                                               
fiscal  stability.  Still  others have  modest  fiscal  stability                                                               
provisions related  to certain taxes. Few  nations provide fiscal                                                               
stability  of  the quality  that  is  being contemplated  in  the                                                               
stranded gas  act. A  number of  nations have  progressive fiscal                                                               
systems without having fiscal stability.                                                                                        
                                                                                                                                
It's possible to pre-design a  strongly progressive fiscal system                                                               
but  you don't  necessarily have  to attach  fiscal stability  to                                                               
progressivity.                                                                                                                  
                                                                                                                                
SENATOR STEDMAN  noted that  the bill  has a  look-back provision                                                               
for recapturing historical  costs by means of a  credit. He asked                                                               
Dr. Van Meurs to comment on how that relates to the report.                                                                     
                                                                                                                                
DR. VAN MEURS explained that  the capital expenditure clawback or                                                               
look-back provision is a recent  innovation that was added to the                                                               
package after he delivered his  report. Mr. Dickenson did most of                                                               
the work on that provision and he would explain it in detail.                                                                   
                                                                                                                                
His  understanding  is  that  the  idea is  to  allow  major  oil                                                               
companies  to  pay  less  tax  and deduct  some  costs  from  the                                                               
previous five-year period. Apparently  that applies only when oil                                                               
is  above $40  per barrel.  He  further understands  that in  the                                                               
entire scheme  of things this  feature is relatively  modest, but                                                               
that doesn't mean that it's unimportant.                                                                                        
                                                                                                                                
5:21:32 PM                                                                                                                    
SENATOR SEEKINS asked if he  still believes that the 25/20 system                                                               
is fair.                                                                                                                        
                                                                                                                                
DR. VAN MEURS  replied from a fiscal point of  view yes, but he's                                                               
aware that the Governor must make decisions on a broader basis.                                                                 
                                                                                                                                
SENATOR SEEKINS commented he hadn't  seen Dr. Van Meurs back down                                                               
from his original report.                                                                                                       
                                                                                                                                
CHAIR  WAGONER thanked  Dr.  Van  Meurs and  asked  Mr. Marks  to                                                               
proceed.                                                                                                                        
                                                                                                                                
5:23:06 PM                                                                                                                    
ROGER MARKS, Petroleum Economist,  Department of Revenue, said he                                                               
would compare the  PPT revenues with the status  quo. He informed                                                               
the  committee that  he would  describe: the  department's model,                                                               
long-term  cumulative revenues,  annual  revenues, and  corporate                                                               
take. Tomorrow he would present how  SB 305 affects small and new                                                               
investors so  the issue  of the $73  million tax  free allowance,                                                               
the  marketability of  credits and  the conversion  of losses  to                                                               
credits would be covered at that time.                                                                                          
                                                                                                                                
To  model how  much money  the  state will  get from  the tax  an                                                               
important  element  is how  much  oil  will be  produced.  That's                                                               
difficult  to  forecast, but  two  scenarios  were examined.  The                                                               
first relates to enhanced exploration  and success in production.                                                               
That could be NPR-A, ANWAR,  the Foothills, or the development of                                                               
heavy oil.  He also looked at  whether or not there's  a gas line                                                               
because  it  affects  oil  production in  three  ways.  First  it                                                               
suppresses oil production  in Prudhoe Bay, but  that would extend                                                               
its life because  many expenses could be shared with  the gas. In                                                               
terms of  net, the estimate  is that production would  drop about                                                               
150 million barrels over about 30 years.                                                                                        
                                                                                                                                
The  second  way a  gas  line  affects  production is  the  Point                                                               
Thompson field. Those unit owners  have represented that it's not                                                               
economic to  produce oil and  reinject the gas to  pressurize the                                                               
reservoir  because  it's  under   such  high  pressure  it's  too                                                               
expensive.  The state  has assumed  that  with a  gas line  Point                                                               
Thompson is possible and without a gas line it isn't.                                                                           
                                                                                                                                
Finally,  between Prudhoe  and Point  Thompson  there's about  35                                                               
trillion  cubic feet  (tcf) of  gas. A  gas line  would carry  at                                                               
least 50 tcf and the belief is  that the additional 15 tcf of gas                                                               
can be found and if the gas  is found additional oil will be with                                                               
the gas.  The model shows about  600 million barrels of  oil with                                                               
yet to find gas.                                                                                                                
                                                                                                                                
MR. MARKS advised that the department  looked at the high and low                                                               
volume  scenarios.  The  low volume  scenario  with  no  enhanced                                                               
volumes and  no gas line  would have 5.5 billion  barrels through                                                               
2030 including  0.8 billion barrels  of heavy oil.  No additional                                                               
investment  for heavy  oil is  modeled at  prices below  $30. The                                                               
volumes indicated  come from the  DOR Fall Revenue  Sources Book,                                                               
which   include  resources   in   development,  resources   under                                                               
development  and resources  under evaluation.  It assumes  no new                                                               
discoveries.                                                                                                                    
                                                                                                                                
The high  volume scenario  with a gas  line and  enhanced volumes                                                               
shows  10.5  billion  barrels  through  2050.  That  includes  an                                                               
additional  3.2  billion barrels  of  conventional  oil with  700                                                               
million barrels net stemming from  the gas line. Also included is                                                               
an additional 1.8 billion barrels  of heavy oil and no additional                                                               
heavy oil at prices under  $30. Reports from state geologists and                                                               
the USGS  indicate that  between ANWR, NPR-A  and state  lands an                                                               
estimated  23 billion  barrels for  the mean  case of  commercial                                                               
reserves  could be  discovered. Therefore,  the volume  scenarios                                                               
range from 5.5 billion barrels to 10.5 billion barrels.                                                                         
                                                                                                                                
5:29:02 PM                                                                                                                    
Slide  6  shows a  graph  of  the  low  and high  scenarios.  The                                                               
fluctuation in  the high volume  line indicates that a  series of                                                               
fields are  coming into production every  five years. Interactive                                                               
effects  were   not  modeled,  but   the  department   knows  the                                                               
following: with  more investment  there is more  production; with                                                               
incentives  there is  more investment;  the  PPT credits  provide                                                               
incentives. It  also knows  that when taxes  are higher  there is                                                               
less  investment  and  when  prices  are  higher  there  is  more                                                               
investment.  Furthermore,  investment  is driven  by  competitive                                                               
international opportunities. What isn't  known is how to quantify                                                               
such future  events, which is why  the model took the  volumes as                                                               
"a  given"  and  attributed  all   revenue  effects  to  the  tax                                                               
mechanics.                                                                                                                      
                                                                                                                                
Mr.  Marks explained  that slide  7 shows  costs and  prices. The                                                               
department assumed the following costs:  $100 million per year in                                                               
exploration  costs  through  2040;  $1  per  barrel  in  on-going                                                               
capital costs  on all  barrels; $3.50  per barrel  in development                                                               
capital on  two-thirds of the  existing conventional oil;  $8 per                                                               
barrel  for development  capital  on two-thirds  of the  existing                                                               
heavy  oil; $3.50  per  barrel in  developmental  capital on  new                                                               
conventional oil;  $8.00 per barrel  in developmental  capital on                                                               
new  heavy   oil;  $3.00  per   barrel  in  operating   costs  on                                                               
conventional  oil; and  $5.00 per  barrel in  operating costs  on                                                               
heavy oil.                                                                                                                      
                                                                                                                                
5:31:57 PM                                                                                                                    
Mr. Marks  explained that the  state has already been  exposed to                                                               
price and  volume volatility  in the  taxes and  it will  also be                                                               
subject  to cost  volatility.  A  sensitivity analysis  indicates                                                               
that  if   the  per  barrel   estimates  for   on-going  capital,                                                               
development capital on conventional  oil, and the operating costs                                                               
are all  off by  $1 that  results in a  $200 million  increase or                                                               
decrease  for the  year.  It  could go  either  way depending  on                                                               
whether the  costs are  higher or  lower, but  the point  is that                                                               
there is exposure to volatility in the PPT.                                                                                     
                                                                                                                                
In  the  model   presented  to  the  House   and  Senate  Finance                                                               
Committees, the  department inflated costs at  2 percent annually                                                               
to  show nominal  dollars. Subsequently  the department  realized                                                               
that  many of  the  results  it was  seeing  are attributable  to                                                               
inflation alone.  To correct for  that, all costs and  prices are                                                               
now shown real 2005 dollars.  To show sensitivities for different                                                               
prices,  heavy  oil  is  discounted 8  percent  for  quality  and                                                               
viscous oil is discounted 4 percent.                                                                                            
                                                                                                                                
Slide 8  relates to cumulative  revenues for low and  high volume                                                               
scenarios. The low volume is through  2030 and the high volume is                                                               
through  2050.  Showing  the  revenue   over  such  a  long  term                                                               
accentuates the  difference in  the volume  scenarios as  well as                                                               
long-term trends. That's particularly so in the current system.                                                                 
                                                                                                                                
He explained  that in  the high  volume scenario,  which includes                                                               
the gas  line, the  numbers shown include  the upstream  costs of                                                               
developing the gas  because that would be subject to  the PPT. It                                                               
doesn't include the severance tax  revenues from gas because they                                                               
will  be included  in  the  gas contract.  Showing  the gas  line                                                               
severance  taxes with  the PPT  and  with the  status quo  fiscal                                                               
system would be a wash so they are not included.                                                                                
                                                                                                                                
He reiterated  the PPT would  include as deductions  the upstream                                                               
costs  for  developing gas  at  Point  Thompson  as well  as  the                                                               
capital costs  for new fields  that are discovered.  He explained                                                               
that the borderline where the PPT  stops is upstream of the point                                                               
of production or  the lease boundary. There would  not be credits                                                               
for the gas treatment plants or the main gas line.                                                                              
                                                                                                                                
Under the  status quo severance  tax at  a $5 Chicago  price, the                                                               
gas line  revenue would amount to  about $1 billion per  year. He                                                               
cautioned that  "if you want  to include  those in your  mind you                                                               
have to add them  for both the status quo and the  PPT as well so                                                               
the thing we're  seeing here is just the  real difference between                                                               
them."                                                                                                                          
                                                                                                                                
5:35:59 PM                                                                                                                    
SENATOR THERRIAULT questioned why he  included costs, but not the                                                               
revenues and asked for a graph showing both.                                                                                    
                                                                                                                                
MR. MARKS said he hadn't done  that because he wanted to focus on                                                               
the  impact of  the  PPT. He  agreed to  provide  that graph  and                                                               
advised that  the difference  between PPT and  the status  quo is                                                               
exactly what would be shown.                                                                                                    
                                                                                                                                
SENATOR THERRIAULT  responded it  would ultimately be  status quo                                                               
and the gas contract.                                                                                                           
                                                                                                                                
5:37:17 PM                                                                                                                    
MR. MARKS  said if PPT doesn't  pass and there is  a gas contract                                                               
there would  be the  severance taxes  from the  gas line  and the                                                               
current severance tax  for oil. If the PPT does  pass and there's                                                               
the same  gas contract there  would be  the PPT oil  revenues and                                                               
the severance  tax from  the gas contract.  Either way,  he said,                                                               
the severance tax from the gas contract is the same.                                                                            
                                                                                                                                
SENATOR THERRIAULT  asked whether  the flat 10  percent severance                                                               
tax for gas would ratchet up.                                                                                                   
                                                                                                                                
MR.  MARKS clarified  there's the  status quo  severance tax  for                                                               
gas, which is 10 percent subject to ELF.                                                                                        
                                                                                                                                
SENATOR   THERRIAULT  interjected   saying   Point  Thompson   is                                                               
amazingly productive and  more than likely the ELF  on that would                                                               
not change.                                                                                                                     
                                                                                                                                
MR. MARKS responded it would have a very high ELF.                                                                              
                                                                                                                                
SENATOR THERRIAULT  added the ELF  isn't the same problem  as for                                                               
the gas that's anticipated.                                                                                                     
                                                                                                                                
MR. MARKS agreed.                                                                                                               
                                                                                                                                
SENATOR THERRIAULT continued  to say that the dynamic  for PPT is                                                               
interesting.  Dr. Van  Meurs  has indicated  that  there is  more                                                               
competition and  more stranded gas  on natural gas and  under PPT                                                               
the proposal is to move from 10  percent up to 20 percent. It's a                                                               
strange dynamic  if there's  more competition  but the  tax isn't                                                               
increased to  potentially make  it less  competitive. Ultimately,                                                               
he  said, the  comparison must  be made  with what's  in the  gas                                                               
contract. Having  that information now would  be illustrative, he                                                               
said.                                                                                                                           
                                                                                                                                
5:40:32 PM                                                                                                                    
MR. MARKS  reminded members  that the numbers  show the  cost for                                                               
the gas  reducing the taxes, but  not the revenues. He  turned to                                                               
Figure 2A  on slide 9,  which compares  status quo and  the 20/20                                                               
PPT under the low volume  scenario. Remember though, he said, the                                                               
current status quo [ELF] is  a modest standard of comparison. The                                                               
graph shows the crossover point is $26.50 ANS West Coast price.                                                                 
                                                                                                                                
Figure 2B  illustrates that  slope is  as important  as crossover                                                               
point. The graph compares hypothetical  Plans A and B against the                                                               
status  quo. Plan  A  would be  a  low tax  rate  and low  credit                                                               
scenario. That crossover  point is $15. Plan B would  be a higher                                                               
credit and  higher tax  rate scenario. The  slope is  steeper and                                                               
the $20  crossover point is higher.  When the ANS price  is above                                                               
$25, Plan  B with the  higher crossover point starts  making more                                                               
money than  Plan A. Clearly,  he said, focusing on  the crossover                                                               
isn't enough; the slope is of equal importance.                                                                                 
                                                                                                                                
SENATOR BEN STEVENS asked what  the crossover point is a function                                                               
of.                                                                                                                             
                                                                                                                                
MR. MARKS said it's mainly the tax rate.                                                                                        
                                                                                                                                
SENATOR  BEN STEVENS  asked if  it's correct  that the  slope has                                                               
higher sensitivity to the tax rate and less to the credit rate.                                                                 
                                                                                                                                
MR. MARKS responded  the credit controls "how up down  it is" and                                                               
the tax rate how steep the slope is.                                                                                            
                                                                                                                                
Slide 11,  Figure 3A  shows the status  quo and  20/20 cumulative                                                               
oil severance taxes between the years  2007 and 2050 for the high                                                               
volume  scenario. The  scale  is larger  than  Figure 2A  because                                                               
there's more oil  over more years. The graph  indicates a higher,                                                               
$33.80,  crossover point.  It includes  the more  expensive heavy                                                               
oil  and  the  gas  line  effects of  costs,  but  not  revenues.                                                               
Depending  on  price  the  total revenues  would  range  from  $3                                                               
billion less at low prices, to $42 billion more at high prices.                                                                 
                                                                                                                                
Figure 3B  shows status quo  and 20/20  for the same  high volume                                                               
scenario as  Figure 3A,  but with  2.5 percent  annual inflation.                                                               
The severance  tax values  on the vertical  axis are  much larger                                                               
and the crossover point drops because  a large quantity of oil is                                                               
sold at inflated prices at the tail end.                                                                                        
                                                                                                                                
Slide 13 lists  annual revenues for high and low  volumes at $20,                                                               
$40, and $60 barrel oil.                                                                                                        
                                                                                                                                
5:45:18 PM                                                                                                                    
Mr.  Marks  suggested that  Figure  4  demonstrates that  at  low                                                               
prices there  are larger  problems than  having chosen  the wrong                                                               
tax system.  Under the  low volume scenario  and $20  barrel oil,                                                               
the average annual revenue is $100 less than the status quo.                                                                    
                                                                                                                                
CHAIR WAGONER  asked Mr. Marks  to clarify  that this is  only 25                                                               
percent of the  overall income from oil  because corporate income                                                               
tax, property tax and royalty wouldn't be affected.                                                                             
                                                                                                                                
5:46:08 PM                                                                                                                    
MR. MARKS responded the property  tax wouldn't be affected but at                                                               
$20 oil  the royalties  and corporate income  taxes would  "be in                                                               
the tank." He reiterated the point  that at low prices, it's hard                                                               
to make money regardless of the tax system.                                                                                     
                                                                                                                                
Figure  5 shows  $40 oil  under  the low  volume scenario.  Under                                                               
these  conditions the  average annual  revenues are  $330 million                                                               
more than the status quo.                                                                                                       
                                                                                                                                
He explained that the transition  rules [Capex clawback] say that                                                               
companies may take a 20  percent deduction for capital costs from                                                               
the last  five years and moving  forward over the next  six years                                                               
if oil prices  are over $40 per barrel. The  graphs were made for                                                               
$40  barrel oil  so  if the  price  moves up  just  one cent  the                                                               
clawback deduction would  apply and the PPT graph  would be about                                                               
$170 million less per year for six years.                                                                                       
                                                                                                                                
5:48:06 PM                                                                                                                    
SENATOR BEN STEVENS asked about $39 barrel oil.                                                                                 
                                                                                                                                
MR. MARKS responded the clawback  doesn't kick in until oil rises                                                               
above $40 so the deduction isn't reflected in the graph.                                                                        
                                                                                                                                
5:49:04 PM                                                                                                                    
Mr. Marks  pointed to  Figure 6, which  illustrates a  low volume                                                               
scenario at  $60 barrel oil.  Under these conditions  the average                                                               
annual revenue for the 20/20 PPT  is about $900 million more than                                                               
under the  status quo and is  equivalent to what the  total state                                                               
gas line revenues would be at $4.70/mmbtu in Chicago.                                                                           
                                                                                                                                
5:49:51 PM                                                                                                                    
SENATOR THERRIAULT  asked if the  clawback had been added  to the                                                               
graphs showing costs.                                                                                                           
                                                                                                                                
MR.  MARKS  said yes;  the  department  estimates that  about  $1                                                               
billion has  been spent in  capital investment each year  for the                                                               
past  five years.  A 20  percent deduction  on $5  billion spread                                                               
over six years is $166 million  per year. That represents the tax                                                               
reduction to the state.                                                                                                         
                                                                                                                                
The rational for the clawback  provision is that if companies had                                                               
known that  PPT was coming they  could have deferred some  of the                                                               
capital expenditures that were made  over the past five years. He                                                               
likened it  to buying an  item from a  store one day  and finding                                                               
that it went on sale the next.                                                                                                  
                                                                                                                                
5:51:20 PM                                                                                                                    
CHAIR WAGONER disagreed with the statement.                                                                                     
                                                                                                                                
5:51:54 PM                                                                                                                    
SENATOR BEN STEVENS  added the business decision was  made on the                                                               
fact  that  it   was  possible  to  amortize  the   life  of  the                                                               
investment, but  with the  change of  system the  amortization of                                                               
the life of the investment isn't there any longer.                                                                              
                                                                                                                                
ROBYNN  WILSON, Director,  Tax Division,  Department of  Revenue,                                                               
clarified that  for state and  federal income tax  purposes there                                                               
is   still   a   depreciation  deduction.   What   is   currently                                                               
contemplated  is moving  to  a production  tax  based on  profit.                                                               
Normally you'd expect depreciation deductions  to be in there but                                                               
the current plan  proposes a write off in year  one of all assets                                                               
purchased. From an accounting standpoint  it's important to match                                                               
income and expenses;  what you have is  recently purchased assets                                                               
that  produce  income  that  will  be taxed  as  income  with  no                                                               
representation  for the  write off  of  those recently  purchased                                                               
assets. She reiterated depreciation  isn't allowed as a deduction                                                               
for  here  on  out,  but  what's  contemplated  is  a  transition                                                               
provision  to  transition taxpayers  and  assets  for a  specific                                                               
period of time.                                                                                                                 
                                                                                                                                
Anytime a new  tax system is put in place  there is consideration                                                               
of transition rules.  This is an important rule  here because the                                                               
proposal is to move from a tax on gross to a tax on net.                                                                        
                                                                                                                                
5:54:40 PM                                                                                                                    
SENATOR BEN STEVENS clarified his  previous statement saying that                                                               
when the investment decision was  made, there was a provision for                                                               
depreciation on the  schedule and this takes it  away meaning the                                                               
depreciation schedule is collapsed.                                                                                             
                                                                                                                                
SENATOR STEDMAN said  it's the impact of the  severance tax today                                                               
versus the PPT tomorrow.                                                                                                        
                                                                                                                                
MS.  WILSON agreed  with Senator  Stedman and  added there  would                                                               
still be federal and state  deductions for depreciation and there                                                               
would  continue to  be  a deduction  on  the company's  financial                                                               
statements. The  production tax is a  move to a system  of tax on                                                               
net  profit so  this is  effectively a  depreciation. New  assets                                                               
will be written off in year  one so there will be no depreciation                                                               
deduction for them under PPT.  Those assets will continue to have                                                               
state and federal depreciation for income tax purposes.                                                                         
                                                                                                                                
SENATOR  BEN  STEVENS  asked  how  an  investor  could  take  the                                                               
deduction plus the  credit on an investment in year  one and then                                                               
use  the   same  investment  and   invest  it  over   the  normal                                                               
amortization life  on the state  and federal side. He  then asked                                                               
whether  the  state  tax  isn't deducted  from  the  federal  and                                                               
corporate obligation.                                                                                                           
                                                                                                                                
MS. WILSON acknowledged  there are several ways to  look at this,                                                               
but in this  instance there are two taxing  authorities that will                                                               
decide how  much of the  pie to  take after having  made separate                                                               
calculations  to determine  how large  the  pie is  in the  first                                                               
place.                                                                                                                          
                                                                                                                                
5:58:06 PM                                                                                                                    
SENATOR BEN  STEVENS said  he's not  concerned about  the federal                                                               
side he's  concerned because  it sounds as  though there  are two                                                               
pies in the state system.                                                                                                       
                                                                                                                                
MS. WILSON responded  the state currently has  a corporate income                                                               
tax based  on profit and  a severance tax that's  currently based                                                               
on gross.  What is contemplated  is leaving the  corporate income                                                               
tax as is and calculating the severance tax differently.                                                                        
                                                                                                                                
There  are  two  taxing  "buckets" and  each  "pie"  is  reviewed                                                               
differently. To calculate the corporate  income taxes, start with                                                               
the  federal  taxable  income  and   work  from  there.  For  the                                                               
severance  tax   the  same  numbers   are  looked  at   a  little                                                               
differently and for a different purpose.                                                                                        
                                                                                                                                
SENATOR BEN STEVENS interpreted that  as a dual accounting system                                                               
on the credit side.                                                                                                             
                                                                                                                                
MS. WILSON said  she was speaking of  deductions for depreciation                                                               
instead  of credits,  but it's  not unexpected  for a  company to                                                               
make three or four different depreciation runs.                                                                                 
                                                                                                                                
6:01:06 PM                                                                                                                    
SENATOR   THERRIAULT  stated   that   there  is   no  change   in                                                               
depreciation in  the state or  federal system, but  the companies                                                               
are  frustrated  because  they   couldn't  take  advantage  of  a                                                               
deduction  to a  system that  didn't  exist five  years ago.  The                                                               
investments were  made, but what  wasn't known is what  the price                                                               
would be  going forward five  years. Now  we know what  the price                                                               
was over  those five  years and  I would  portray, he  said, that                                                               
those companies have been well  rewarded for the investments they                                                               
made. It's  certainly understandable why the  companies would ask                                                               
for  the clawback,  but he  couldn't understand  why it  would be                                                               
granted.                                                                                                                        
                                                                                                                                
6:02:20 PM                                                                                                                    
SENATOR ELTON  posed a  hypothetical scenario.  Company X  made a                                                               
$100,000  capital investment  in 2001  and  on July  1, 2006  the                                                               
depreciated value is $50,000. He  asked if the clawback provision                                                               
would provide  20 percent of  $100,000 rather than 20  percent of                                                               
$50,000. If  that's the  case he questioned  why the  state would                                                               
agree to that.                                                                                                                  
                                                                                                                                
MS. WILSON replied  the interpretation is correct.  It could have                                                               
been done on  depreciated value and although  that was considered                                                               
the bill isn't written that way.                                                                                                
                                                                                                                                
6:04:03 PM                                                                                                                    
SENATOR STEDMAN said if the bill  is enacted and a company buys a                                                               
piece  of equipment  and  depreciates it  over  five years  there                                                               
would be  a depreciation schedule  on the state  corporate income                                                               
tax and there would also be a credit in the purchase year.                                                                      
                                                                                                                                
MS. WILSON answered yes.                                                                                                        
                                                                                                                                
SENATOR STEDMAN continued to say that  in year two there would be                                                               
no credit,  but there would  still be a depreciation  schedule of                                                               
four years.                                                                                                                     
                                                                                                                                
MS.  WILSON  said  for  federal  purposes  yes,  but  as  far  as                                                               
production tax is concerned they  got a deduction for 100 percent                                                               
of the equipment in year one  and assuming that the credit wasn't                                                               
carried over, they  took the credit in year one  as well. In year                                                               
two they have nothing.                                                                                                          
                                                                                                                                
6:05:25 PM                                                                                                                    
SENATOR THERRIAULT asked  if there was any data  available on the                                                               
investments made  over the  five year period  with regard  to the                                                               
fields  the investments  were  make  in or  the  wells that  were                                                               
drilled.                                                                                                                        
                                                                                                                                
MR. MARKS responded if SB  305 passes, the department would audit                                                               
those  costs. There's  already general  knowledge that  money was                                                               
spent in Prudhoe  Bay, Kuparuk, Alpine, and North  Star, but it's                                                               
confidential  taxpayer   data  so   he  wasn't  sure   about  the                                                               
provisions for providing that.                                                                                                  
                                                                                                                                
SENATOR THERRIAULT  expressed frustration that those  who delayed                                                               
investment would now be rewarded for going forward.                                                                             
                                                                                                                                
6:06:43 PM                                                                                                                    
SENATOR  ELTON  said this  creates  a  distortion to  the  system                                                               
because  the credits  don't  need to  be taken  in  the year  the                                                               
investment was  made. They  could be  used in an  out year  for a                                                               
larger  tax advantage  or the  credits could  be sold  to another                                                               
party.                                                                                                                          
                                                                                                                                
MR. MARKS clarified  it isn't a credit; it's  a deduction against                                                               
net income  subject to the 20  percent tax rate for  the next six                                                               
years unless  prices are very  low. As long  as oil is  above $40                                                               
there isn't an option for when the benefit is realized.                                                                         
                                                                                                                                
MS.  WILSON  suggested  the  committee   hold  the  question  for                                                               
Assistant Attorney General Mintz and Dan Dickenson.                                                                             
                                                                                                                                
6:09:02 PM                                                                                                                    
MR. MARKS turned  Figures 7, 8 and 9, which  show the high volume                                                               
scenarios for $20-$60 oil prices.  For $20 oil the average annual                                                               
revenues for  20/20 PPT are $110  less than the status  quo. When                                                               
the price is $40, the average  annual revenues are $190 more than                                                               
the status  quo and for $60  oil the average annual  revenues are                                                               
$800 million more than the status quo.                                                                                          
                                                                                                                                
Figures 10 and  11 show graphs of the effective  tax rate for low                                                               
and  high  volume  scenarios  based on  the  wellhead  value.  He                                                               
reminded  members that  the tax  rate is  currently based  on the                                                               
wellhead  value, which  is the  market price  less transportation                                                               
costs with no consideration of the  lease costs. With the PPT the                                                               
tax rate is a flat 20 percent of net income.                                                                                    
                                                                                                                                
Under  the  current   system  the  effective  tax   rate  is  ELF                                                               
multiplied by  the nominal 15  percent rate. Figure 10  shows the                                                               
effective tax  rate on the  same low  volume basis with  the PPT.                                                               
The effective  tax is defined  as severance tax over  the 25-year                                                               
period divided  by the  wellhead value  less the  royalties. With                                                               
the ELF and  unaffected by price it's about a  5 percent tax rate                                                               
under the status quo regardless of  price. With the 20/20 PPT the                                                               
system is  progressive with  regard to  wellhead value.  When the                                                               
ELF  was passed  in 1977  it  was intended  to give  a number  of                                                               
barrels  tax-free to  cover  operating costs.  As  prices go  up,                                                               
fewer barrels  would be needed so  the tax rate would  go up with                                                               
price.                                                                                                                          
                                                                                                                                
SENATOR  ELTON questioned  whether it's  taken into  account that                                                               
the wellhead  price would be  different for company Y  that isn't                                                               
an  owner of  the  transportation  system than  it  would be  for                                                               
company X that is a partial owner of the transportation system.                                                                 
                                                                                                                                
MR.  MARKS  replied  the  statutes accept  public  tariffs  as  a                                                               
suitable transportation deduction.                                                                                              
                                                                                                                                
SENATOR ELTON  observed that  company Y, as  a part  owner, would                                                               
receive a profit from the transportation system.                                                                                
                                                                                                                                
MR.  MARKS agreed  then turned  to  the high  volume scenario  in                                                               
Figure 11 and noted that it is much the same.                                                                                   
                                                                                                                                
6:12:51 PM                                                                                                                    
MR.  MARKS concluded  his  comments with  a  review of  corporate                                                               
take.  Figure 12  compares corporate  take at  the Department  of                                                               
Energy (EIA)  forecast price of  $58 barrel gas under  the status                                                               
quo  and the  20/20 PPT  for a  high volume  scenario. The  graph                                                               
shows  the  breakdown of  the  projected  $600 billion  in  gross                                                               
revenue  over  the  next  45  years  [2007-2050].  The  breakdown                                                               
includes:  Capex,   Opex  [operating   expenses],  transportation                                                               
costs, property  tax, royalty, state CIT,  severance tax, federal                                                               
tax and finally the corporate take.                                                                                             
                                                                                                                                
Focusing  on  severance  tax,  federal  tax  and  corporate  take                                                               
illustrates that  the severance tax  increases under PPT  and the                                                               
federal  income tax  is noticeably  less under  PPT. Because  the                                                               
severance tax  is deductible for federal  corporate income taxes,                                                               
the feds are picking up 35  percent of the tab from the companies                                                               
for the PPT.  The corporate take difference under  the status quo                                                               
is about  33 percent and  under PPT  it's about 30  percent. That                                                               
means the corporation  is left with about 30 percent  of the $600                                                               
billion, which is $180 billion.                                                                                                 
                                                                                                                                
MR.  MARKS  informed  members  that  he would  be  happy  to  run                                                               
additional models if the committee so desired.                                                                                  
                                                                                                                                
6:14:48 PM                                                                                                                    
SENATOR  BEN   STEVENS  asked  him  to   reiterate  the  modeling                                                               
assumptions.                                                                                                                    
                                                                                                                                
MR. MARKS  recapped the  following: The  high volume  scenario is                                                               
for the  years between  2007 and  2050. Multiplying  10.5 billion                                                               
barrels  of  oil by  the  Los  Angeles  price  of $58  yields  an                                                               
estimated $600 billion in gross revenues in real 2005 dollars.                                                                  
                                                                                                                                
CHAIR WAGONER asked Ms. Wilson to review the fiscal note.                                                                       
                                                                                                                                
6:16:09 PM                                                                                                                    
MS. WILSON  pointed out  that in terms  of expenses  the division                                                               
assumes   expanded  auditing   duties   and   because  the   bill                                                               
contemplates  expanding the  credit  program  so credit  auditing                                                               
would  increase.  The  division  proposes  to  handle  the  added                                                               
responsibility  with  three  additional  auditor  positions.  She                                                               
advised that  she also  provided for a  tax technician  to handle                                                               
the additional  filings. Producers  currently file monthly  and a                                                               
yearly filing  will be added to  "true up" the payments.  The tax                                                               
technician would handle the increased  filings and the additional                                                               
auditors would handle the increased audits.                                                                                     
                                                                                                                                
6:18:09 PM                                                                                                                    
She drew  attention to contractual  positions and stated  that is                                                               
need  for  immediate  temporary  audit  help.  As  Mr.  Dickenson                                                               
indicated  yesterday  about  $5  billion in  assets  need  to  be                                                               
audited  right  away,  because the  transition  deduction,  which                                                               
affects the depreciation, will be taken immediately.                                                                            
                                                                                                                                
The second critical issue relates  to writing regulations and the                                                               
overhead   allocations   because   they  need   to   be   written                                                               
immediately.  She stated  that  she  envisions using  contractual                                                               
money to  hire outside  auditors and  help with  the regulations.                                                               
The  last piece  relates to  increased costs  for the  additional                                                               
programming that will be required.                                                                                              
                                                                                                                                
On  the revenue  side the  assumptions  that have  been made  are                                                               
listed and should  mirror Mr. Marks' presentation.  It also gives                                                               
the revenue  projections under three  price scenarios.  The first                                                               
is the Department of Revenue  (DOR) forecast prices from the fall                                                               
Revenue  Sources Book.  She reminded  members that  those numbers                                                               
were  on a  chart  she  presented on  2/23/06.  The second  price                                                               
scenario is  for $40 barrel oil  and the third is  for $60 barrel                                                               
oil.                                                                                                                            
                                                                                                                                
CHAIR  WAGONER questioned  how easy  it  would be  to find  three                                                               
auditors.                                                                                                                       
                                                                                                                                
6:21:14 PM                                                                                                                    
MS. WILSON acknowledged that is a challenge.                                                                                    
                                                                                                                                
There were  no further  questions or  comments and  Chair Wagoner                                                               
held SB 305 in committee.                                                                                                       
                                                                                                                                
There being  no further  business to  come before  the committee,                                                               
Chair Wagoner adjourned the meeting at 6:21:47 PM.                                                                            
                                                                                                                                

Document Name Date/Time Subjects