Legislature(2005 - 2006)BUTROVICH 205

03/07/2006 03:30 PM RESOURCES

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03:39:25 PM Start
03:39:25 PM SB305
03:41:08 PM Department of Revenue - Michael Williams, Chief Petroleum Economist
04:19:44 PM Administration - Dan Dickinson, Cpa
04:52:13 PM Department of Revenue – Robynn Wilson, Director, Tax Division – Addressed Legislature’s Questions – with Dan Dickinson
05:46:13 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
-- Agenda to be Announced --
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                         March 7, 2006                                                                                          
                           3:39 p.m.                                                                                            
MEMBERS PRESENT                                                                                                               
Senator Thomas Wagoner, Chair                                                                                                   
Senator Ben Stevens                                                                                                             
Senator Fred Dyson                                                                                                              
Senator Bert Stedman                                                                                                            
Senator Kim Elton                                                                                                               
Senator Albert Kookesh                                                                                                          
MEMBERS ABSENT                                                                                                                
Senator Ralph Seekins, Vice Chair                                                                                               
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                                                                                           
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02/23/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/23/06       (S)       Heard & Held                                                                                           
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02/24/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/24/06       (S)       Heard & Held                                                                                           
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02/25/06       (S)       RES AT 9:00 AM BUTROVICH 205                                                                           
02/25/06       (S)       -- Reconvene from 02/24/06 --                                                                          
02/25/06       (H)       RES AT 10:00 AM SENATE FINANCE 532                                                                     
02/25/06       (S)       Heard & Held                                                                                           
02/25/06       (S)       MINUTE(RES)                                                                                            
02/27/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/27/06       (S)       Heard & Held                                                                                           
02/27/06       (S)       MINUTE(RES)                                                                                            
02/28/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/28/06       (S)       Heard & Held                                                                                           
02/28/06       (S)       MINUTE(RES)                                                                                            
03/01/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
03/01/06       (S)       Heard & Held                                                                                           
03/01/06       (S)       MINUTE(RES)                                                                                            
03/02/06       (S)       RES AT 1:30 PM BUTROVICH 205                                                                           
03/02/06       (S)       Heard & Held                                                                                           
03/02/06       (S)       MINUTE(RES)                                                                                            
03/02/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
03/02/06       (S)       Heard & Held                                                                                           
03/02/06       (S)       MINUTE(RES)                                                                                            
03/03/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
03/03/06       (S)       -- Meeting Canceled --                                                                                 
03/04/06       (S)       RES AT 10:00 AM SENATE FINANCE 532                                                                     
03/04/06       (S)       Presentation by Legislative Consultants                                                                
03/06/06       (S)       RES AT 3:30 PM SENATE FINANCE 532                                                                      
03/06/06       (S)       Heard & Held                                                                                           
03/06/06       (S)       MINUTE(RES)                                                                                            
03/07/06       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
WITNESS REGISTER                                                                                                              
MICHAEL D. WILLIAMS, Chief Petroleum Economist                                                                                  
Tax Division                                                                                                                    
Department of Revenue                                                                                                           
550 West 7th Avenue, Suite 500                                                                                                  
Anchorage, AK  99501-3566                                                                                                       
POSITION STATEMENT:  Testified on SB 305 and answered questions.                                                              
DAN DICKINSON, CPA                                                                                                              
Consultant for the Governor                                                                                                     
Office of the Governor                                                                                                          
PO Box 110001                                                                                                                   
Juneau AK 998811-0001                                                                                                           
POSITION STATEMENT: Testified on SB 305.                                                                                      
ROBYNN WILSON, Director                                                                                                         
Tax Division                                                                                                                    
Department of Revenue                                                                                                           
PO Box 110400                                                                                                                   
Juneau, AK  99811-0400                                                                                                          
POSITION STATEMENT:  Presented Questions and Answers  relating to                                                             
SB 305.                                                                                                                         
ACTION NARRATIVE                                                                                                              
CHAIR  THOMAS  WAGONER  called   the  Senate  Resources  Standing                                                             
Committee meeting to order at  3:39:25 PM.  Present were Senators                                                             
Ben  Stevens,  Bert Stedman,  Fred  Dyson,  Kim Elton  and  Chair                                                               
Thomas Wagoner; Senator Kookesh arrived shortly thereafter.                                                                     
               SB 305-OIL AND GAS PRODUCTION TAX                                                                            
3:39:25 PM                                                                                                                    
CHAIR WAGONER  announced SB 305 to  be up for consideration.   He                                                               
noted the committee would begin  with hearing a presentation from                                                               
the Department of Revenue.                                                                                                      
^DEPARTMENT  OF  REVENUE  -  Michael  Williams,  Chief  Petroleum                                                             
3:41:08 PM                                                                                                                    
MICHAEL  D. WILLIAMS,  Chief Petroleum  Economist, Tax  Division,                                                               
Department of  Revenue (DOR), gave  some personal  background and                                                               
said he would speak about  future crude oil production volumes in                                                               
Alaska.  First, however, he would address earlier forecasts.                                                                    
SENATOR KOOKESH arrived at 3:41:08 PM.                                                                                        
MR.  WILLIAMS  showed  a  slide   labeled  "Fall  Oil  Production                                                               
Forecasts,"  pointing out  that with  the exception  of one  data                                                               
point on  the graph, forecasts  have overestimated  production in                                                               
Alaska.   There are two reasons.   First, the Prudhoe  Bay field,                                                               
having produced  for close  to 30 years,  is subject  to problems                                                               
associated with  an aging  field such as  leaks in  pipelines and                                                               
second, the  North Slope's viscous oil  requires new technologies                                                               
to  develop.  Many of  these  projects  have  been delayed  as  a                                                               
result.  The  department's  forecast  for  heavy  oil  production                                                               
reflects this delay.                                                                                                            
3:44:53 PM                                                                                                                    
In  the  near  term,  DOR  has  incorporated  revised  reservoir-                                                               
performance   analyses  for   declining   fields,  reviewed   the                                                               
uncertainty  associated with  the  pace and  scope of  developing                                                               
satellite  fields  and  reevaluated  unplanned  downtime  at  all                                                               
fields, especially Prudhoe  Bay. This resulted in  an average net                                                               
reduction of  about 30,000  barrels a  day a  year over  the next                                                               
five  years. Roughly  half this  reduction  relates to  reservoir                                                               
performance and facility downtime; the  other half relates to the                                                               
pace of  development of heavy  oil, primarily  at West Sak.   The                                                               
forecast  for  ANS  production averages  slightly  above  800,000                                                               
barrels a day for FY 07 through FY 11.                                                                                          
He explained  that ANS crude  oil production is  characterized in                                                               
three  ways   -  1) currently   producing,  2)   currently  under                                                               
development  and  3) currently under  evaluation  -  each with  a                                                               
discrete   estimated    confidence   level.    Highlighting   the                                                               
uncertainty  of production  forecasting,  Mr. Williams  indicated                                                               
DOR continues to  forecast production of only  reserves that have                                                               
already  been  discovered  and   that  are  being  evaluated  for                                                               
MR. WILLIAMS  showed a graph  labeled "ANS Historical  & Forecast                                                               
Production:   Millions  of Barrels  per  day, FY  1978-2005 &  FY                                                               
2006-2016" and  said the "currently producing"  category includes                                                               
baseline   production  and   presumes   a   continued  level   of                                                               
expenditure  sufficient to  promote  safe, environmentally  sound                                                               
3:47:50 PM                                                                                                                    
He noted  such expenditures include well  diagnostic and remedial                                                               
work,  in   addition  to  data  acquisition   and  rate-enhancing                                                               
expenditures  such  as  perforating and  acid  stimulation,  well                                                               
work-overs,  fracture  treatments, artificial  lift  optimization                                                               
and  production-profile  optimization.   This  category  presumes                                                               
continued gas  and water injection  for pressure support.   Based                                                               
on historical  forecasting performance, DOR assigns  a 98 percent                                                               
confidence level for the current fiscal years.                                                                                  
He  next addressed  the "under  development" area  on the  graph,                                                               
which  is based  on  new  projects currently  funded  and in  the                                                               
design  or construction  phase, as  well as  development drilling                                                               
and  enhanced  oil  recovery,  whether  miscible  or  immiscible,                                                               
injection  projects currently  funded  or underway.   It  doesn't                                                               
include  those  same  projects  if they  are  in  the  "currently                                                               
producing" category.   It also includes  incremental oil expected                                                               
from  the long-term  gas cap  water-injection project  at Prudhoe                                                               
Bay and  the low-salinity water  flood at Endicott.   Examples of                                                               
production  under  development  include   the  Fiord  and  Nanook                                                               
satellite fields  at Alpine, the  remaining J Pad  development at                                                               
West  Sak, development  drilling  at Schrader  Bluff and  certain                                                               
satellite developments at Prudhoe Bay.                                                                                          
He reported that the pace  of development at all heavy-oil fields                                                               
has  been  slowed  to  allow  proper  mitigation  of  challenging                                                               
commercial and  technical issues.   Because  of timing  and scope                                                               
uncertainty, Mr.  Williams said, DOR's subjective  confidence for                                                               
this category of production is lower, 80-85 percent.                                                                            
He  turned  to the  "under  evaluation"  category on  the  graph,                                                               
noting it  includes technically viable projects  currently in the                                                               
"pencil  sharpening"  stage  where engineering  costs,  risk  and                                                               
reward  are   being  actively  evaluated.     Although  currently                                                               
unfunded by the  operators, these projects have a  high chance of                                                               
being brought  to fruition.   They include enhanced  oil recovery                                                               
at  certain satellite  fields, development  drilling outside  the                                                               
core areas  at West Sak  and Schrader Bluff  expanded development                                                               
at Prudhoe Bay satellites including  Orion, Polaris and Borealis,                                                               
and  Alpine  West  development.     Also  included  are  National                                                               
Petroleum  Reserve-Alaska  (NPR-A)  development,  Point  Thomson,                                                               
Liberty   and  development   of   other   onshore  and   offshore                                                               
MR. WILLIAMS said  DOR is forecasting production  from four small                                                               
pools  in  the  vicinity  of known  discoveries  currently  named                                                               
Lookout,  Moose's  Tooth,  Spark  and Rendezvous  in  the  NPR-A.                                                               
Since these  discoveries were announced,  there has  been ongoing                                                               
exploration outside  their boundaries  and explorers  continue to                                                               
push further west in search of new development opportunities.                                                                   
He  explained   that  confidence  levels  vary   by  category  of                                                               
production.    Certain  heavy-oil drilling  for  Schrader  Bluff,                                                               
Orion or West Sak in  2007 may have confidence levels approaching                                                               
those in the category "under  development."  In general, however,                                                               
offshore  development such  as Liberty  or potentially  high-cost                                                               
development such  a Point Thomson deserve  lower confidence; thus                                                               
DOR's subjective assessment is 70-75 percent.                                                                                   
He noted all  production from this category is  subject to delays                                                               
and  scope  changes  that might  impact  reserves  or  production                                                               
rates.   For  example,  Point  Thomson has  been  delayed in  the                                                               
forecasts three  times since 2000.   There are 65,000  barrels of                                                               
day of natural gas liquids  (NGLs) associated with Point Thomson.                                                               
However, a delay  at Point Thomson also  delays 35,000 additional                                                               
barrels associated with the satellite fields.                                                                                   
He informed  members that many details  surrounding this forecast                                                               
are  based  on petroleum  engineering  knowledge.   His  advanced                                                               
degree is in economics, but he  has lived in Alaska only one year                                                               
and  isn't  intimate with  details  regarding  all these  fields.                                                               
Thus  for the  more involved  questions relating  to geology  and                                                               
engineering,  he'd turn  to the  petroleum engineer  who prepared                                                               
these forecasts.                                                                                                                
He  concluded  by  saying developing  crude  oil  resources  will                                                               
require significant  investment in time  and capital.   Under the                                                               
governor's  proposed tax  system,  the  petroleum production  tax                                                               
(PPT) creates a fiscal framework  that provides strong incentives                                                               
for  exploration  and  reduces  the  risk  in  capital  costs  of                                                               
development.   Most  important, it  provides a  long-term revenue                                                               
stream  to   the  state  by  encouraging   new  participants  and                                                               
supporting new developments.                                                                                                    
3:53:27 PM                                                                                                                    
MR. WILLIAMS, in  response to Chair Wagoner,  indicated he'd just                                                               
come  from a  press  conference  at which  the  summary data  was                                                               
released  for  DOR's revenue  forecast.    For  FY 06,  when  all                                                               
volumes are  put together with  the price forecast, it  comes out                                                               
to about $4  billion; for FY 07 it's about  $3.4 billion; and for                                                               
FY  08  it's close  to  $3  billion.   He  agreed  to e-mail  his                                                               
presentation to the committee aide.                                                                                             
3:54:03 PM                                                                                                                    
SENATOR  BEN  STEVENS  requested clarification  about  the  first                                                               
slide, "Fall Oil Production Forecasts."                                                                                         
MR.  WILLIAMS explained  that the  point estimates  are forecasts                                                               
for  each  fiscal  year  going  out  to  2010  that  consistently                                                               
overestimated what actually occurred on the production side.                                                                    
3:55:57 PM                                                                                                                    
MR. WILLIAMS,  in response to  Chair Wagoner, indicated  he could                                                               
find  out percentages  relating  to the  aforementioned from  the                                                               
petroleum engineer.                                                                                                             
CHAIR  WAGONER  requested that  Mr.  Williams  send that  to  the                                                               
committee along with the presentation.                                                                                          
3:56:30 PM                                                                                                                    
MR.  WILLIAMS responded  further  about the  graph  on the  first                                                               
slide, saying  those are  just volumes.   Affirming that  the new                                                               
forecast released today  shows new production as  well, he agreed                                                               
the graph  doesn't show  the projected drop  of 30,000  barrels a                                                               
year for  the next five  years.  He said  the FY 06  forecast for                                                               
the North Slope is 854,000 barrels  a day; for FY 07 it's 825,000                                                               
barrels a day; and for FY 08 it's 803,000 barrels a day.                                                                        
3:58:43 PM                                                                                                                    
MR.  WILLIAMS  reported he  and  the  petroleum engineer,  Dudley                                                               
Platt, figured  out that the aging  field at Prudhoe Bay  and the                                                               
heavy oil caused virtually all  the problems with overestimating;                                                               
thus  Mr. Platt  was taking  those two  factors into  account and                                                               
trying to  be more  realistic.  Expressing  support for  the good                                                               
job  Mr. Platt  had done,  Mr. Williams  said  these issues  also                                                               
highlight the  fact that the  state needs investment  to maintain                                                               
and possibly increase production.                                                                                               
4:00:21 PM                                                                                                                    
SENATOR BEN  STEVENS opined  that as much  as the  production has                                                               
been overprojected,  revenue has  been under projected.  He added                                                               
that  the  new   release  says  revenues  are   up,  even  though                                                               
production is down.                                                                                                             
MR.  WILLIAMS replied  that in  the last  ten years,  prices were                                                               
underestimated  four times  and  overestimated four  times.   The                                                               
Office  of  Management  and Budget  (OMB)  compared  DOR's  price                                                               
forecasts  with  those  of  three   other  organizations  -  U.S.                                                               
Department  of  Energy,  NYMEX,  and  Cambridge  Energy  Research                                                               
Associates -  and found  DOR's to  be the best,  though not  to a                                                               
statistically significant  degree.   Thus he  encouraged positive                                                               
thinking about DOR's ability to forecast crude oil prices.                                                                      
4:01:41 PM                                                                                                                    
SENATOR  BEN  STEVENS  asked  about  the  accuracy  of  oil-price                                                               
forecasts  and  its  relationship  to  the  Henry  Hub  price  or                                                               
"futures  prices of  gas."   He  asked  whether Mr. Williams  was                                                               
familiar with  a "six to  eight times"  multiplier and if  he had                                                               
used it as part of the formula.                                                                                                 
MR. WILLIAMS replied he was  familiar, but not intimate, with it.                                                               
Crude  oil  is an  international  commodity  traded on  exchanges                                                               
worldwide; a  price for crude oil  in London will be  the same in                                                               
New   York   and   everywhere,  accounting   for   transportation                                                               
differentials.  For natural gas  - different in this country from                                                               
liquefied natural gas (LNG) shipped  around the world - there are                                                               
two large oceans  on either side and very little  gas comes north                                                               
or south.  Thus the gas  price at Henry Hub has constraints based                                                               
on  the  available supply  within  this  country.   There  aren't                                                               
enough import facilities  to import enough gas  to balance supply                                                               
and demand, part  of the reason the relationship  between gas and                                                               
oil is so difficult to forecast.                                                                                                
He  affirmed there  is a  six-to-one relationship,  based on  Btu                                                               
content and  the ability  to substitute  natural gas  for certain                                                               
products.  For  example,  gas  or petroleum  could  be  used  for                                                               
feedstock  in  production  of petrochemical  products.    In  the                                                               
bigger  picture, however,  natural-gas  prices at  Henry Hub  are                                                               
constrained because there isn't enough supply.                                                                                  
The natural gas industry has  been regulated in this country from                                                               
1969  to  1998;  many  industries   were  established  and  built                                                               
pipelines to bring gas in.   In 1996-1998, that changed.  Many of                                                               
those  companies are  now having  difficulty  because gas  prices                                                               
have gone so high.   For instance, the petrochemical industry has                                                               
about  a third  fewer  people  than ten  years  ago.  He said  he                                                               
doesn't know  what will  happen with gas  prices or  whether that                                                               
six-to-one  ratio  will  be  there  in  the  future.  Forecasting                                                               
natural  gas  for the  U.S.  is  far  more challenging  than  oil                                                               
because of  the limited time  in which  it has been  available on                                                               
the free  market.  Since December  13, for example, the  price at                                                               
Henry  Hub has  dropped  57 percent.   Furthermore, Mr.  Williams                                                               
said he  didn't know how  the industries  would "play out."   For                                                               
instance,  would   petrochemical  just  shift   their  production                                                               
capacity to  someplace like Qatar?   That would  influence demand                                                               
for natural gas on the commercial side.                                                                                         
SENATOR BEN STEVENS expressed  appreciation for hearing something                                                               
he hadn't heard before.                                                                                                         
4:06:04 PM                                                                                                                    
SENATOR  STEDMAN  asked whether  Mr.  Williams  planned to  do  a                                                               
"trumpet-type" graph  depicting a low,  medium and high  range in                                                               
terms  of price  and volume,  to  show what  might reasonably  be                                                               
4:07:13 PM                                                                                                                    
MR. WILLIAMS replied  he was looking at that and  believed it had                                                               
been done  in the past.  It's rather challenging to  do, however,                                                               
because if  distribution range  is too  wide, it  provides almost                                                               
worthless information.   In further  response, he said  the long-                                                               
term crude oil price forecast after FY 09 is $25.50 a barrel.                                                                   
4:08:07 PM                                                                                                                    
SENATOR  STEDMAN  asked  what  time  period  was  addressed  when                                                               
Mr. Williams  talked about  DOR's  accuracy  in forecasting  when                                                               
compared with the other three organizations.                                                                                    
MR. WILLIAMS  answered, "The only  period we've evaluated  is the                                                               
one-year out."                                                                                                                  
SENATOR STEDMAN suggested  the $25 estimate could  move, then, as                                                               
time marches forward.                                                                                                           
MR.  WILLIAMS concurred  that  the further  into  the future  DOR                                                               
looks, the less accurate the forecasts likely will be.                                                                          
CHAIR  WAGONER thanked  Mr. Williams  and agreed  it was  nice to                                                               
hear something new.                                                                                                             
4:10:32 PM                                                                                                                    
^ADMINISTRATION - DAN DICKINSON, CPA                                                                                          
DAN  DICKINSON, CPA,  former director  of the  DOR Tax  Division,                                                               
began  by reacting  to issues  raised by  testifiers in  the last                                                               
couple of days.  With  regard to auditing direct expenditures, he                                                               
told  members  that  in auditing  "upstream"  costs,  substantial                                                               
weight is given to the industry  practice as of December 1, 2005,                                                               
before  people  were  entering into  arrangements  perhaps  as  a                                                               
consequence  of this  bill.   He also  mentioned ways  of dealing                                                               
with  costs  that  were  subject  to  negotiation  with  working-                                                               
interest  owners  that   were  not  the  operator   and  who  had                                                               
substantial  bargaining  power.   Out  of  perhaps 20  ANS  units                                                               
including  exploration   units,  maybe   only  three   meet  that                                                               
criterion. He explained:                                                                                                        
     What we're  looking at are  places where you have  a BP                                                                    
     and an Exxon or a ConocoPhillips.   One of those is the                                                                    
     operator;  the   other  two  are  looking   over  their                                                                    
     shoulder and  they don't want  a penny spent  more than                                                                    
     has to be  spent. My point is if we  have those kind of                                                                    
     things  going on,  if  we have  that  kind of  auditing                                                                    
     going on,  is there some  way we can take  advantage of                                                                    
MR. DICKINSON  proposed that, although  it would be great  if the                                                               
state  had a  field of  auditors looking  at every  invoice, that                                                               
isn't realistic and  if safeguards can be created  to ensure that                                                               
the state's interests aren't compromised,  then the thorough work                                                               
already being done by industry can be used.                                                                                     
He  emphasized   that  the  right   policy  choice  is   to  give                                                               
substantial weight  to what  the producers  do when  dealing with                                                               
each other, but  do it in a  manner that leaves the  state in the                                                               
proper position.  He highlighted  the need to  look at  what data                                                               
can be  used effectively  and to look  at internal  controls like                                                               
how  the auditing  is being  done and  any changes  the producers                                                               
make in the operating agreements.   He disagreed with Jim Eason's                                                               
[Legislative  consultant]  suggestion   that  giving  substantial                                                               
weight to  how the producers  do things might hinder  the state's                                                               
ability to question what has been going on.                                                                                     
He addressed a  second issue:  Mr. Eason's concern  that if there                                                               
is only one agency doing  the work, there won't be crosschecking.                                                               
Mr.  Dickinson agreed  that  having two  people  do something  is                                                               
better  than   one,  but  limited   resources  don't   make  that                                                               
necessarily practical.  Currently, two  groups of  state auditors                                                               
apply slightly  different rules to  the same set  of calculations                                                               
to  come up  with royalties  and severance  taxes. Mr.  Dickinson                                                               
proposed that  one set is  probably good enough,  especially with                                                               
the market's  transparency and  if the  DNR commissioner  has the                                                               
authority to set the conditions  under which a calculation can be                                                               
He  explained  that the  DL-1  leases  were written  before  spot                                                               
markets became transparent and the  royalty value in them was the                                                               
higher of  four measures:  1)  the value of the  oil, 2) what the                                                               
company sold  the oil  for, 3)  what others sold  the oil  for or                                                               
4) the posted  price.  However, when  it came time to  settle the                                                               
Amerada  Hess royalty  issues in  the  1980s and  to establish  a                                                             
"going forward" basis, DNR said  the following: it believed there                                                               
was a transparent market for the  value of oil; it didn't believe                                                               
transactions were being  done which hid that; and  it would start                                                               
with this publicly  reported number of what oil sells  for in the                                                               
marketplace,   using  it   as  the   netback,   instead  of   the                                                               
aforementioned number based on the higher of the four values.                                                                   
He indicated, similarly,  that AS 43.55.020(f) gives  the DOR the                                                               
ability to  look at the sales  price and then impose  a tax based                                                               
on it  or on the prevailing  value if the production  wasn't sold                                                               
at market  value.  Mr. Dickinson  opined that while  the concerns                                                               
expressed  by  Mr. Eason were  valid,  they  are met  by  putting                                                               
sufficient safeguards in place.                                                                                                 
4:19:44 PM                                                                                                                    
MR. DICKINSON  turned to comments  by Daniel  Johnston suggesting                                                               
the state  shouldn't be worse  off after the change  than before.                                                               
One possibility  is to leave  the economic limit factor  (ELF) in                                                               
place and do  a "higher of" calculation.   However, Mr. Dickinson                                                               
spoke against  leaving the ELF  in place saying he  believed what                                                               
was being  done with  the bill  made sense  and that  some places                                                               
cited  by Mr. Johnston  had a  tax system  as their  only way  of                                                               
getting  revenues. Nova  Scotia, for  example, has  no additional                                                               
royalty, income tax or property tax.                                                                                            
He noted half the state's  general revenues come from the royalty                                                               
and that isn't  affected in this bill, which  turns the severance                                                               
tax  into  a   different  vehicle  to  be   used  to  incentivize                                                               
production;  when there  is a  fair  amount of  profit from  that                                                               
production, the  state will take  its fair share.   Mr. Dickinson                                                               
opined that having  an alternative tax or an  alternative ELF tax                                                               
isn't as critical as it would be if it were the only source.                                                                    
4:21:04 PM                                                                                                                    
MR.  DICKINSON began  his slide  presentation,  saying he'd  talk                                                               
about the  point of  production and how  it affects  both royalty                                                               
and tax for oil and gas. He  said the current tax system has been                                                               
pretty simple.  The state  knew what  it wanted  and put  it into                                                               
statute in  the 1970s. The  definitions are not being  changed in                                                               
the proposal, but rather being simplified.                                                                                      
He  showed the  slide "Oil  or  Gas -  Why does  it matter?"  and                                                               
explained that under current rules it  matters a great deal.  Gas                                                               
is taxed at 10 percent of the gross,  and a gas ELF looks only at                                                               
how productive  each well is.   In contrast,  oil is taxed  at 15                                                               
percent  times an  ELF that  takes into  account both  the well's                                                               
productivity and the field size.                                                                                                
Another  aspect  under  current  rules   is  that  gas  used  for                                                               
production operations on the North  Slope is free; this condition                                                               
is found  in practically all gas-producing  states. The condition                                                               
says if the  ultimate purpose of an operation  is oil production,                                                               
the gas can be used as fuel and  for heating at no charge.  Using                                                               
oil for those purposes is not free.                                                                                             
He  corrected a  second slide,  relating to  proposed rules  that                                                               
should say  "past" rather than "post"  production.  Mr. Dickinson                                                               
reported that each barrel of  oil has a conservation surcharge of                                                               
3 to 5 cents, depending  on various conditions; however, there is                                                               
no conservation surcharge for gas.                                                                                              
4:23:39 PM                                                                                                                    
MR. DICKINSON explained  that in part the bill  says perhaps some                                                               
of those  shouldn't matter quite as  much and taxes both  oil and                                                               
gas at 20  percent of the net  with free use of both  gas and oil                                                               
for production purposes.   He found in 1996 research  that of the                                                               
20 oil-producing states,  seven have tax-free use of  gas and oil                                                               
as long as  it's for production purposes; the other  14 only give                                                               
that  to gas,  while  oil  is taxed.  He  noted the  conservation                                                               
surcharge would be creditable.                                                                                                  
4:24:32 PM                                                                                                                    
SENATOR DYSON  asked what production  purposes oil could  be used                                                               
MR. DICKINSON  answered that some  products are made at  a "crude                                                               
oil topping  plant" -  for example,  low diesel  that is  used in                                                               
well work  and as  fuel for  vehicles.  Another  major use  is as                                                               
miscible injectant.                                                                                                             
4:24:57 PM                                                                                                                    
MR. DICKINSON recalled that this  morning Mr. Mintz had suggested                                                               
using just one  category - "produced hydrocarbons" -  and thus no                                                               
distinction between oil and gas would be needed.                                                                                
CHAIR  WAGONER  asked  the reason  for  making  the  conservation                                                               
surcharge creditable  and why  the recent  North Slope  oil spill                                                               
could be used as a credit.                                                                                                      
MR.  DICKINSON replied  that right  now the  actual costs  of the                                                               
emergency  response,  including  cleaning up  and  "fixing"  that                                                               
event,  aren't  deductible.   However,  the  resulting  decreased                                                               
production  would decrease  the  amount of  tax  and royalty  the                                                               
state  gets.   Under the  proposal,  the state  would allow  both                                                               
preparing  for  such  a  crisis  and  then,  if  it  did  happen,                                                               
responding to it would be deductible.                                                                                           
CHAIR WAGONER pointed out that  several state positions are being                                                               
funded from that revenue stream that will be reduced.                                                                           
4:26:42 PM                                                                                                                    
MR.  DICKINSON  replied that  the  proposal  wouldn't reduce  the                                                               
revenue stream  to the spill fund;  3 to 5 cents per  barrel will                                                               
still go to the fund. The  money going to the fund would actually                                                               
increase a  little bit  because the  definitions are  changing to                                                               
just  look at  profits.    However, with  the  credit, the  total                                                               
amount of general fund revenues would be smaller.                                                                               
CHAIR WAGONER asked, "Why are we saying that?"                                                                                  
4:27:38 PM                                                                                                                    
MR. DICKINSON replied  that they were trying to do  a profits tax                                                               
that  minimized the  small regressive  components. The  intent of                                                               
the tax is  to look at profitability and tax  that 20 percent. If                                                               
you're not profitable, it's nothing.  They were trying to get rid                                                               
of the  philosophically point of  view of some  smaller additions                                                               
to the base tax.                                                                                                                
4:28:19 PM                                                                                                                    
MR.  DICKINSON  emphasized  that  concerns  about  the  point  of                                                               
production relate to the definitions of  oil and gas and for oil,                                                               
there is no real change. But,  for gas the point of production is                                                               
driven by the "point of final separation."                                                                                      
He   asked,  "Why   does  the   point   of  production   matter?"                                                               
Historically, the point of production  was very important because                                                               
costs incurred  downstream of it were  deductible for calculating                                                               
production  tax,  while costs  incurred  upstream  weren't.   You                                                               
could  deduct  tankers,  TAPS  and   the  Kuparuk  pipeline,  for                                                               
instance,  but as  soon as  you hit  the Kuparuk  boundary, costs                                                               
were no longer  deductible. A billion dollar  facility within the                                                               
boundary was not deductible.                                                                                                    
In a  parallel situation  with royalty,  the point  of production                                                               
made all  the difference. In 1978,  the point of production  on a                                                               
royalty lease  form was ambiguous  and therefore,  was negotiated                                                               
between the state  and the producers who said that  it was at the                                                               
wellhead  where the  oil comes  out of  the ground  and that  all                                                               
costs were  deductible. A field  cost settlement  was established                                                               
at that time to cover  upstream costs that included inflation and                                                               
it is currently at about $1 a barrel.   His point was that as you                                                               
move the point of production  upstream, then something downstream                                                               
of that becomes deductible. That is  why, until now, the point of                                                               
production has been critically important.                                                                                       
This bill's  intent is  to incentivize  those costs  beyond being                                                               
just  a  deduction. The  point  of  production remains  important                                                               
because, even though costs are  deductible from both sides of the                                                               
point  of  production, how  they  are  recaptured is  still  very                                                               
different.  Downstream  costs  remain traditional,  but  upstream                                                               
costs are different.  The state is saying you spend  a capital $1                                                               
and you get to deduct it  immediately and, furthermore, you get a                                                               
20-cent  credit  that can  be  applied  against profits  for  any                                                               
obligation. The  point of production  is still a  critical issue.                                                               
This  is one  of the  reasons gas  processing, which  used to  be                                                               
downstream of the point of production, now moves upstream.                                                                      
4:32:57 PM                                                                                                                    
MR.  DICKINSON said  under the  old  rules, the  state gives  gas                                                               
processing a reasonable allowance. Now  in the proposed bill, the                                                               
investment  for  the  gas  processing   plant  would  be  both  a                                                               
deduction and  a credit.   Moving  to the  next slide,  he opined                                                               
that  the point  of production  would matter  particularly for  a                                                               
newcomer without heritage facilities who  has found gas ten years                                                               
down  the road  and wants  access to  the production  facilities.                                                               
Even now,  some folks who  are discovering oil have  alleged that                                                               
access  is  difficult.    He  stressed  that  the  dynamic  would                                                               
dramatically  change and  a new  producer would  be able  to just                                                               
build his own  plant, knowing he'll get 40 percent  credit for it                                                               
from the government.                                                                                                            
He   submitted  that   if   existing   heritage  facilities   are                                                               
underutilized, its  owner would  know how much  it would  cost to                                                               
build and  that knowledge  could help  frame negotiations  with a                                                               
new  entrant.  He   offered  the  belief  that   moving  the  gas                                                               
processing  costs  upstream  of  the point  of  production  would                                                               
significantly change  how people  think about costs  and facility                                                               
sharing.  He advised this  isn't the only solution members should                                                               
think about  for that particular  problem, but to the  degree the                                                               
tax code  can be  used, he  thought it  would make  a significant                                                               
4:35:00 PM                                                                                                                    
SENATOR  ELTON asked  what the  most  important thing  for a  new                                                               
entrant would be for access to a facility or the pipeline.                                                                      
MR. DICKINSON  replied that  it's not  his job  to say  that. But                                                               
what  the   department  says  is  that   pipelines  are  publicly                                                               
regulated and access  to them should be based only  on the charge                                                               
for   that  access,   which  should   reflect  a   cost  recovery                                                               
methodology -  in other  words, standard  rate-making procedures.                                                               
The  question with  TAPS has  been whether  those processes  were                                                               
circumvented in  the settlement or aren't  representative of true                                                               
costs. He  wouldn't recommend suddenly  moving all the  points of                                                               
production downstream of  the pipeline.  Where the  line is drawn                                                               
between gas  (and oil)  processing, treatment  and pipeline  is a                                                               
choice that folks have to make.                                                                                                 
4:36:57 PM                                                                                                                    
The next slide  deals with what happens when  you have production                                                               
and post-production  facilities in  the same building.  Under the                                                               
current rules, if a central  gas facility has both gas processing                                                               
(which removes valuable  liquid hydrocarbons that will  end up in                                                               
TAPS) and  production activity  (which is  simply taking  the gas                                                               
and conditioning  it so you  can put through compressors  and put                                                               
it back  down in the ground  again), together and because  one is                                                               
deductible and one  isn't, costs have to be  allocated. Under the                                                               
proposed rules, both of those activities would be deductible.                                                                   
4:39:57 PM                                                                                                                    
Slide 9 gets into what is the  point of production for the gas or                                                               
the  oil. The  statute  says that  oil must  be  in the  pipeline                                                               
quality condition and that has been  defined as being in good and                                                               
merchantable condition. Gas that  is produced in association with                                                               
oil  is  actually metered  downstream  from  the point  of  final                                                               
separation. Both  of the definitions  remain unchanged,  but they                                                               
are dealing with the point of final separation.                                                                                 
The  question has  been  raised  that the  state  has this  great                                                               
standard for  oil. So, why  can't the same  be done for  gas? His                                                               
observations were that  historically, gas is often  sold with the                                                               
liquids  still in  it  (wet) and  so it  doesn't  have the  clear                                                               
merchantability  standard that  crude oil  has. Secondly,  if you                                                               
did that, you would be  essentially saying that gas treatment and                                                               
the gas treatment  plant would now move upstream of  the point of                                                               
production  and   would  be  allowable  for   these  credits  and                                                               
     So, we  believe that having this  condition of pipeline                                                                    
     quality  good and  merchantable  emission  is good  for                                                                    
     oil. We're  going to leave  it for oil. We  don't think                                                                    
     moving that over  to make it the same  standard for gas                                                                    
     makes as much sense.                                                                                                       
MR.  DICKINSON  said  the  definition  of  gas  in  the  proposal                                                               
includes  what  happens  if  a  big facility  is  built  for  gas                                                               
treatment and the  point of production would be in  the middle of                                                               
that facility. The  point of this slide was that  is true and the                                                               
state may end up in the same kind of cost allocation issues.                                                                    
4:42:11 PM                                                                                                                    
He   recommended   keeping  the   gas   treatment   as  part   of                                                               
transportation  and the  downstream where  it is  deductible, but                                                               
doesn't need the additional credit or upfront help.                                                                             
4:43:36 PM                                                                                                                    
The next  slides dealt with  where the point of  production (POP)                                                               
is for  gas and oil  now. This bill  proposes moving the  POP for                                                               
gas, not oil,  which would put the central  gas facility upstream                                                               
from the POP.  Everything going through it would  be considered a                                                               
production operation.  When the  NGLs are taken  out of  the gas,                                                               
the LACT meter is the point at which they become oil.                                                                           
4:46:16 PM                                                                                                                    
He said  the question was  asked if this was  absolutely critical                                                               
to  the PPT  and  the answer  was  no. The  goal  is to  simplify                                                               
definitions that will  not lead to low  value-added conflicts and                                                               
to incentivize all production activity including gas processing.                                                                
Another question was could the  state retain the same definitions                                                               
of  POP  and still  get  most  of the  benefits  of  the PPT?  He                                                               
answered yes and emphasized that  the administration is trying to                                                               
create a clear way of dealing with the issues.                                                                                  
4:47:20 PM                                                                                                                    
SENATOR DYSON  asked where  gas and  oil were  taken off  for in-                                                               
field use in each of the diagrams.                                                                                              
MR. DICKINSON  replied under  the current plan  that oil  will be                                                               
diverted  to  a   topping  plant  as  it  is   flowing  from  the                                                               
facilities. The topping  plant has another little  meter where it                                                               
begins to be taxed.                                                                                                             
In the  separation facilities some gas  is used for gas  lift and                                                               
things like  that, but  it is simply  recycled in  the separation                                                               
facilities. The  major streams of  fuel that are used  go through                                                               
all  the  processing   at  the  central  gas   facility  and  are                                                               
essentially  identical to  what  is  put down  in  the ground  to                                                               
pressurize the reservoir. By that time it is basically methane.                                                                 
MR. DICKINSON explained:                                                                                                        
     The new scheme  should be the exact  same thing. Again,                                                                    
     what  would   happen  is,  even  though   it  would  be                                                                    
     downstream of the  point of production for  gas for the                                                                    
     stuff that  is used on the  lease, it will be  as if it                                                                    
     were not produced.... They will,  in fact, meter it and                                                                    
     they have  to figure out as  to who has done  what - so                                                                    
     it will go  through that meter, but it  won't trigger a                                                                    
     point of production or taxability.                                                                                         
He said that oil would be treated the same way.                                                                                 
CHAIR  WAGONER thanked  him for  his  presentation. He  announced                                                               
that they  would next go hear  the Tax Division's answers  to the                                                               
Legislature's remaining questions.                                                                                              
4:51:01 PM                                                                                                                    
^DEPARTMENT OF REVENUE - Robynn  Wilson, Director, Tax Division -                                                             
Addressed legislature's questions - with Dan Dickinson                                                                        
ROBYNN  WILSON, Director,  Tax  Division,  Department of  Revenue                                                               
(DOR) explained  that she would  address the  remaining questions                                                               
plus a few more.                                                                                                                
4:52:13 PM at ease 4:53:30 PM                                                                                               
1. Identify  values/amounts for  the "look-back"  or transitional                                                               
deduction per year according to  the actual by type (exploration,                                                               
development, production).                                                                                                       
   The Department of  Revenue model uses  $1 billion per  year as                                                               
   capital costs. So for the transitional  period, there would be                                                               
   about $5 billion. These annual costs are based on compilations                                                               
   of historical data. [Graph is in bill file.]                                                                                 
4:54:36 PM                                                                                                                    
SENATOR DYSON asked  where she drew the  line between exploration                                                               
and development.                                                                                                                
MS. WILSON  replied the  bill has  no definition  for exploration                                                               
versus  development. The  IRS code  makes a  distinction, because                                                               
generally,  exploration  costs   are  fully  deductible;  whereas                                                               
development  falls under  the  category  of "intangible  drilling                                                               
costs" and those are capitalized.                                                                                               
SENATOR  DYSON asked  what  the difference  in  the equipment  or                                                               
activity in the field was.                                                                                                      
MS.  WILSON replied  that the  exploration  would include  things                                                               
like seismic, geologic and geophysical.                                                                                         
4:55:28 PM                                                                                                                    
MR.  DICKINSON added  that the  information is  collected from  a                                                               
number of sources, but basically  for their purposes, exploration                                                               
would be pretty close to wildcat drilling of delineation wells.                                                                 
SENATOR  DYSON  asked if  development  water,  EOR (enhanced  oil                                                               
recovery) and all those things were considered development.                                                                     
MR. DICKINSON replied that was correct.                                                                                         
4:56:11 PM                                                                                                                    
SENATOR ELTON asked if she had numbers for 2005.                                                                                
She replied that she didn't have finalized numbers for 2005.                                                                    
SENATOR ELTON estimated the number to  be in the $6 billion range                                                               
for 2005.                                                                                                                       
MR.  DICKINSON responded  that 2001  would only  be one-half  the                                                               
cost because  they are  using calendar year  costs that  run from                                                               
July to  July. The department's extrapolations  indicate that the                                                               
downward trend  is continuing through  2005 and 2006.  He thought                                                               
the number would be closer to $5 billion.                                                                                       
8. Which  other tax  regimes - worldwide  - have  a progressivity                                                               
   Ms. Wilson  cautioned that she  had heard a lot  of references                                                               
   to  progressivity   and  each  person  may   have  a  slightly                                                               
   different definition.  For example,  in the income  tax world,                                                               
   progressivity generally means as  your net taxable income goes                                                               
   up, the tax  rate goes up. But, she has  also heard talk about                                                               
   progressivity with  respect to  the price  of oil  per barrel.                                                               
   That  means if  the price  of  oil is  $60, you  would have  a                                                               
   different  tax rate  than if  it was  $40. She  suggested that                                                               
   they  might be  ignoring the  cost. So,  the taxpayer  that is                                                               
   doing what  the state wants  by reinvesting is  suddenly being                                                               
   taxed  at a  rate that  is  higher on  what is  left than  the                                                               
   taxpayer  that  doesn't reinvest.  She  cautioned  them to  be                                                               
   careful on  what they are  measuring the  progressivity about.                                                               
   Dr.  Van Muers'  pointed  out  that a  lot  of countries  base                                                               
   progression  on   production.  "So,   are  we   talking  about                                                               
   increasing  tax rate  based  on net  profits?  Are we  talking                                                               
   about increasing it based on price per barrel or are we                                                                      
   talking about, maybe, production? I don't know that there is                                                                 
   a right answer."                                                                                                             
SENATOR  STEDMAN  interrupted  to  say  that  regimes  that  were                                                               
regressive in nature were royalty  tax-based systems. The regimes                                                               
around  the world  that are  rate-of-return based  are production                                                               
profit sharing and are progressive in  nature. So as the price of                                                               
oil goes  up, the split  between the government and  the industry                                                               
rises to the advantage of the government.                                                                                       
MS.  WILSON  continued  saying   that  progressive  features  are                                                               
relatively common  around the world. She  presented the committee                                                               
with a list of the main fiscal regimes with such features.                                                                      
5:02:50 PM                                                                                                                    
18. The State of Alaska has  relied on the services and expertise                                                               
of multiple  outside law  firms to handle  disputes over  oil and                                                               
gas issues. Have you conferred  with such counsel in the drafting                                                               
or  review of  this legislation?  If so,  have they  assessed the                                                               
impacts of the legislation on  the State's legal position in past                                                               
agreements, current disputes, or future disputes?                                                                               
   Yes, such counsel (not all of them) have been consulted and                                                                  
   such assessments have been discussed but have not generally                                                                  
   been generated in formal written form.                                                                                       
Did such advice result in any changes to the legislation?                                                                       
   The bills reflect discussions with counsel that took place                                                                   
   during the drafting process, so in that sense such advice did                                                                
   affect the legislation.                                                                                                      
5:03:27 PM                                                                                                                    
SENATOR BEN STEVENS  asked if royalty is a  progressive system in                                                               
price and recalled that Dr. Van  Muers' said the PPT flattened it                                                               
out. He  asked if  he interpreted  that wrong.  He asked  if they                                                               
were benchmarking  the progressivity against profit  or the price                                                               
or the total government take.                                                                                                   
MR.  DICKINSON replied  that using  it they  way Senator  Stedman                                                               
did,  generally  the  royalty  would  be  considered  regressive,                                                               
because no  cost is deducted and  it's based only on  revenue. As                                                               
the dollar  per barrel  increases, the  take stays  constant. And                                                               
because  no  costs  are  deductible,  as you  get  close  to  not                                                               
covering costs, the state is still taking dollars.                                                                              
SENATOR BEN STEVENS  said he thinks of progressivity  in terms of                                                               
total dollar  value. The state's  share either stays the  same or                                                               
increases  (significantly in  some instances)  - compared  to the                                                               
status quo. He asked if that was accurate.                                                                                      
MR. DICKINSON replied:                                                                                                          
   I think  that as prices  go up under our  current system,                                                                    
   the  state makes  a  lot more  money.  The forecast  just                                                                    
   released  said $1.6  billion. But  our percentage  of the                                                                    
   gross has fallen.                                                                                                            
SENATOR BEN STEVENS said, "Right, so that's regressive."                                                                        
MR. DICKINSON agreed.                                                                                                           
SENATOR BEN STEVENS  said he was comparing the old  system to the                                                               
new system.                                                                                                                     
MR. DICKINSON  responded that the  proposed system would  be less                                                               
progressive than the  old system. Technically speaking  it is not                                                               
progressive at 20/20.                                                                                                           
5:09:08 PM                                                                                                                    
SENATOR  STEDMAN supposed  that even  under a  regressive system,                                                               
the  state's total  dollars might  increase, but  the percent  of                                                               
government  take  would  decrease.   At  the  London  seminar  he                                                               
attended, he learned  from industry to think  of progressivity or                                                               
regressivity in terms  of percentages rather than  dollars as the                                                               
dollar prices moved.  "From their viewpoint, no  matter where the                                                               
money was spent,  it didn't matter. If it didn't  go to them they                                                               
didn't care - call it a tax,  call it a royalty, call it anything                                                               
you want to."                                                                                                                   
He  said Dr.  Van Muers  combined the  proposed bill  using 25/20                                                               
with the current  royalty and tax structure and it  resulted in a                                                               
virtual flat government  take. He said the  discussion was should                                                               
the  government   take  have  been   upward  of  that,   flat  or                                                               
regressive. At a minimum he thought  it should be flat and that's                                                               
what he presented.  They need to remember that as  the price goes                                                               
up, more revenue would come to  the state even under a regressive                                                               
5:12:43 PM                                                                                                                    
SENATOR ELTON picked $40 at 20/20  and said for every $1 increase                                                               
in a barrel  of oil a quarter  point was added. He  asked if that                                                               
would have more progressivity.                                                                                                  
MR. DICKINSON replied yes.                                                                                                      
5:13:50 PM                                                                                                                    
SENATOR BEN STEVENS  said he was fascinated  that the Legislature                                                               
was  mesmerized on  the percent  of  government take.  Government                                                               
depends  on  a flow  of  money,  not  a  percent of  a  declining                                                               
resource.  He kept  coming  back to  what  the government  should                                                               
frame its  policy on when it  tries to secure a  reliable revenue                                                               
stream. He  thought in a  true progressive system  the government                                                               
gives up more as  the price goes down - all the  way down to zero                                                               
tax at zero profit.                                                                                                             
5:17:05 PM                                                                                                                    
SENATOR  STEDMAN steered  thinking  back  toward Senator  Elton's                                                               
discussion  on  progressivity.  If   the  state  takes  a  higher                                                               
percentage when prices  go up, it takes away the  upside from the                                                               
industry and it is  only fair to go back to the  other end of the                                                               
curve  and   adjust  for  it.   "You  can't  have   an  extremely                                                               
progressive system  and then go  back to  the low price  side and                                                               
start putting in floors. There's no balance there."                                                                             
5:18:38 PM                                                                                                                    
MS. WILSON  jumped in with  an example to hopefully  add clarity.                                                               
If oil is  at $100 a barrel and the  producer produces one barrel                                                               
and has  expenses of  $90 and,  therefore, a  net profit  of $10.                                                               
Next year  the price of  oil falls to  $10 a barrel;  he produces                                                               
one  barrel and  doesn't invest  anything and  his net  profit is                                                               
still  $10.  So,  if  the   state  is  talking  about  basing  an                                                               
increasing tax  rate simply on the  price of oil, those  two $10-                                                               
profits are  going to  both enjoy  - for  instance, a  15 percent                                                               
rate when  oil is  $10, and a  25 percent rate  when oil  goes to                                                               
$100  - both  scenarios  have  a $10  profit,  but  in the  first                                                               
instance when  oil is $100  a barrel,  the producer has  $2.50 in                                                               
tax  and for  the second  example, $1.50  in tax.  She emphasized                                                               
that both taxes  are on the same profit. She  cautioned people to                                                               
keep intent in mind.                                                                                                            
5:21:01 PM                                                                                                                    
SENATOR  BEN STEVENS  said he  wanted  to get  attention off  the                                                               
government take, because that's not what the change does.                                                                       
5:23:27 PM                                                                                                                    
SENATOR DYSON reminded the committee  that under the Constitution                                                               
and the Statehood Compact the gas  belongs to the people and they                                                               
should be rewarded on the upside.                                                                                               
5:26:11 PM                                                                                                                    
SENATOR STEDMAN  said keeping an  eye on the  cash flow -  at the                                                               
end of the day - was important.                                                                                                 
5:26:59 PM                                                                                                                    
MR. DICKINSON reminded  them that they were  discussing the long-                                                               
term  cash flow  and  how  to make  sure  it's  robust under  all                                                               
5:27:43 PM                                                                                                                    
MS. WILSON continued with the questions and answers.                                                                            
24. What  standard will be used  to determine whether oil  or gas                                                               
is of 'pipeline quality' under  the definition of 'gross value at                                                               
the point of production'?                                                                                                       
MS. WILSON said  that Mr. Dickinson covered this  question in his                                                               
presentation and this is a  written description of it. She wanted                                                               
to  skip  that one.  The  Chair  indicated  that way  okay.  [The                                                               
following answer was provided in her letter.]                                                                                   
   The current production  tax statute taxes the  "gross value at                                                               
   the point  of production"  of oil and  gas. The  quoted phrase                                                               
   was  enacted  in  1977 and  replaced  the  previous  statutory                                                               
   phrase "gross  value at  the well." This  change was  aimed at                                                               
   ensuring  that costs  of production  operations downstream  of                                                               
   the well  would not be  deductible in calculating  the taxable                                                               
   value  of  oil   or  gas;  rather,  taxable   value  would  be                                                               
   calculated at the point that production is complete.                                                                         
   In the case  of oil, "gross value at the  point of production"                                                               
   was defined  as the  value of  oil where it  is metered  "in a                                                               
   condition  of pipeline  quality," and  "pipeline quality"  was                                                               
   defined as "good and  merchantable condition." This definition                                                               
   essentially adopts  commercial standards of  marketability for                                                               
   oil.  HB  488  and  SB  305 would  simplify  and  shorten  the                                                               
   definition of gross  value at the point of  production for oil                                                               
   but do not  materially change it. In  addition, the definition                                                               
   of  "oil"   is  broadened   to  include   liquid  hydrocarbons                                                               
   recovered  by  gas  processing  in   the  case  of  leases  or                                                               
   properties whose production is  subject to gas processing. The                                                               
   bottom line is that the  point of production under these bills                                                               
   would still be  the point where oil is metered  in a condition                                                               
   of  pipeline quality,  and "pipeline  quality" would  mean the                                                               
   same  thing  it has  always  meant  under the  production  tax                                                               
   In the case  of gas, neither the existing statute  nor the new                                                               
   bills  use   the  phrase  "pipeline  quality"   or  "good  and                                                               
   merchantable  condition" with  respect to  gross value  at the                                                               
   point  of production.  Rather,  the  statutory definitions  of                                                               
   "gross  value  at  the  point   of  production"  for  gas,  as                                                               
   interpreted and clarified by  the Department's regulations, 15                                                               
   AAC 55.900(a)(6)(B) and (C), focus  on where gas is accurately                                                               
   metered after separation  from oil. The new  bills retain this                                                               
   concept  but, in  effect, expand  "separation" to  include gas                                                               
   processing, so that in the  case of leases or properties whose                                                               
   production  is  subject  to  gas   processing,  the  point  of                                                               
   production for  gas recovered by  gas processing is  the point                                                               
   where it is metered downstream of the processing.                                                                            
5:28:42 PM                                                                                                                    
25. Provide  an historical analysis  of the results  of valuation                                                               
methodologies adopted  by the  Department of  Revenue, Department                                                               
of Natural  Resources (under all agreements),  and the Department                                                               
of  the  Interior. She  asked  Mr.  Dickinson  if that  had  been                                                               
covered. He suggested going to  the last paragraph [But the whole                                                               
answer has been included for clarity].                                                                                          
   While there  is much  that is parallel  in the  calculation of                                                               
   gross  value at  the wellhead  between royalty  and tax,  many                                                               
   differences have developed. Both  start with destination value                                                               
   in the  market and then  subtract the tankering,  pipeline and                                                               
   other costs to  arrive at a wellhead value.  The Department of                                                               
   Revenue's   valuation  for   tax   comes   from  statute   and                                                               
   regulation.  The Department  of  Natural Resources'  valuation                                                               
   for  royalty  comes  from   lease  contracts  supplemented  by                                                               
   Royalty   Settlement  Agreements   (RSAs),  which   set  forth                                                               
   different methods  for each large North  Slope producer. (Cook                                                               
   Inlet valuation is not covered in this answer.)                                                                              
   Destination value, for the Department  of Revenue, is what the                                                               
   oil was sold for or when the oil  is not sold or is sold for a                                                               
   below market  price - the  so-called prevailing value  or spot                                                               
   price.  Destination  value  for   the  Department  of  Natural                                                               
   Resources  is a  formula  driven by  the ANS  or  a basket  of                                                               
   similar crudes.                                                                                                              
   From  the  destination  value, each  method  subtracts  marine                                                               
   transportation  costs, TAPS  costs (including  tariffs, losses                                                               
   and quality  bank changes  from mid-point  refineries), feeder                                                               
   line  costs  (including  tariffs,   losses  and  quality  bank                                                               
   differences), and  other miscellaneous costs. DOR  deducts the                                                               
   costs specific  to each taxpayer,  while for royalty,  some of                                                               
   the RSAs have formulaic deductions  and others use the royalty                                                               
   payers' actual  cost. In addition,  DNR subtracts  field costs                                                               
   for most  DL-1 lease  form leases on  the North  Slope whereas                                                               
   DOR does not.                                                                                                                
   The differences  between wellhead  values narrow  across time.                                                               
   The average  difference for the  period FY00  through December                                                               
   2005 is 3.9  percent. However, the average  difference for the                                                               
   last 12  months is  6.1 percent  while the  average difference                                                               
   for FY00 through FY03 is 3.0 percent.                                                                                        
   The critical point is that  DOR uses actual proceeds, and only                                                               
   resorts the Prevailing  Value (PV) when the  conditions of 020                                                               
   (f) are met,  thereby taxing on the higher of  proceeds or PV.                                                               
   For  each   of  the  three   producers,  DNR  uses   a  single                                                               
   destination  formula   based  on   spot  prices,   not  actual                                                               
5:29:56 PM                                                                                                                    
34. Of  the pre-PPT credit  provisions (the claw back),  how many                                                               
investment credits  were sold under SB  185 and how do  we ensure                                                               
the  person who  holds the  credit, not  the original  recipient,                                                               
gets the credit?                                                                                                                
   a. Only  two credits that have  been issued have been  sold to                                                               
   another party.                                                                                                               
   b. The Division will first  obtain a waiver of confidentiality                                                               
   from the  seller allowing the  Division to confirm  the credit                                                               
   amount to  the prospective purchaser. Once  sold, the Division                                                               
   makes the transfer and issues  a new credit certificate to the                                                               
   purchaser upon  receipt of  documentation and  confirmation of                                                               
   the  transaction from  the seller  of the  credit. The  credit                                                               
   exists  as  an  electronic   entry  in  a  Division  database,                                                               
   therefore only  the Division can  make the actual  transfer of                                                               
   the credit in  that database. A new certificate  is entered in                                                               
   the  database to  the  purchaser and  the  old certificate  is                                                               
   marked  as transferred  and  its balance  is  zeroed out.  The                                                               
   Division then notifies  both the purchaser and  the seller, in                                                               
   writing, of  the completed  transfer of  the credit,  at which                                                               
   time  the purchaser  may  then  apply the  credit  to its  own                                                               
   production tax  liability. When a  credit is applied to  a tax                                                               
   liability  by  a  producer, the  Division  then  verifies  the                                                               
   holder and  amount of  the claimed  credit against  the credit                                                               
   certificates in the database.                                                                                                
5:31:30 PM                                                                                                                    
40. Do other nations with a net profit system have the 90                                                                       
percent payment of taxes with the sure-up provision the                                                                         
following year? What is the economic impact of this change?                                                                     
   a.  Net profits  systems in  the world  typically work  on the                                                               
   basis of three different concepts:                                                                                           
   (a) Monthly payments based on  actual production, revenues and                                                               
   expenditures, without  an annual  true-up, as  is the  case in                                                               
   most production sharing agreements                                                                                           
   (b) Yearly payments  based on a yearly return,  filed within a                                                               
   few  months  after  the  year,  without  a  need  for  monthly                                                               
   payments on  account, as  is the  case for  the Thai  SRB, for                                                               
  instance. This means there is only a single annual payment.                                                                   
   (c) Yearly payments  based on a yearly return,  filed within a                                                               
   few months  after a  calendar year  or a  lease/contract year,                                                               
   with  monthly payments  on  account. In  this  last case,  the                                                               
   monthly payments could be based on:                                                                                          
   a. Estimates  for each  month, as for  instance with  the Nova                                                               
   Scotia  profit   sharing  royalty.  These  estimates   can  be                                                               
   challenged  by  government  and  different  estimates  may  be                                                               
   b. Payments based on a  mixture of actual information from the                                                               
   previous month and estimates, such as in Algeria                                                                             
   c.  Corporate income  tax style  procedures, whereby  payments                                                               
   are based  on taxes  paid in  the prior  year (Norway  for the                                                               
   Hydrocarbon Tax).                                                                                                            
   The  90  percent  rule  proposed for  Alaska  is  unique.  The                                                               
   overall economic  impact would  depend on the  taxpayers' cost                                                               
   estimates  for  each  month. We  expect  that  taxpayers  will                                                               
   experience underpayments  in some months, but  will experience                                                               
   overpayments (because  of estimates used) in  other months. In                                                               
   addition,  falling  production  amounts, or  unforeseen  costs                                                               
   will  serve to  likely  create overpayments  in later  months.                                                               
  Overall, we do not expect any material net economic impact.                                                                   
5:33:10 PM                                                                                                                    
66. The discussion of oil field needs, i.e. not to deplete the                                                                  
gas pressure, did not recognize the COre-injection. How will                                                                    
that lengthen the field life(s) and at what volumes, i.e. how                                                                   
will it affect taxes?                                                                                                           
   At Prudhoe Bay,  about 8.5 billion cubic feet of  gas a day is                                                               
   reinjected  into the  field  for  pressure maintenance.  After                                                               
   stripping out  certain hydrocarbon liquids, CO2  is reinjected                                                               
   along  with  the  other hydrocarbons  (and  non-hydrocarbons).                                                               
   When an export line is built  on the North Slope, the CO2 will                                                               
   be stripped (in  "gas treatment"), and there  is some question                                                               
   about what will happen with that CO2.                                                                                        
5:33:52 PM                                                                                                                    
CHAIR  WAGONER asked  why is  there  a question  about what  will                                                               
happen to Co2.                                                                                                                  
MR.  DICKINSON replied  that  the  question is  that  the co2  is                                                               
either  a valuable  product or  a waste  product and  are modeled                                                               
differently for  the different  applications. For  this question,                                                               
CO2 is  just with  the gas and  is not part  of the  tax picture.                                                               
When a gas line occurs, that would  be one of the issues to focus                                                               
5:34:47 PM                                                                                                                    
67. What happens  if the "Big Three" sell off  their assets to 20                                                               
smaller  companies? Will  the significant  tax  benefits ever  be                                                               
   Assume 20 new companies suddenly  showed up on the North Slope                                                               
   and each  qualified for  the $73  million dollar  allowance. A                                                               
   total  of $1.4  billion  in profits  would  be sheltered  from                                                               
   taxes. If these  companies had simply purchased  their way in,                                                               
   then taxes would be lower by  $280 million (20 percent of $1.4                                                               
   billion) than they  would be otherwise. At  current prices, or                                                               
   say even at $40 oil, this  could be a material portion (though                                                               
   not all) of the tax.                                                                                                         
   If that is the future of the  North Slope and the sell off was                                                               
   for business purposes,  the Legislature may choose  to act and                                                               
   make it less attractive to new  firms coming in. If these were                                                               
   tax-motivated sales,  we hope the  powers of  the commissioner                                                               
   that are  built into the  bill would prevent the  new entrants                                                               
   from using  the $73  million allowance. The  commissioner gets                                                               
   to approve qualification for the $73 million allowance.                                                                      
5:36:21 PM                                                                                                                    
73. Will the new confidentiality  provisions extend to or have an                                                               
effect on any other taxes besides the production tax?                                                                           
   The new  confidentiality language added  by secs. 4 and  16 of                                                               
   the bill applies  only to information relating to  the oil and                                                               
   gas production tax, not other taxes. This is because:                                                                        
          (1)  AS 43.55.040(1)  addresses information  "necessary                                                               
          to compute the amount of  the tax," and the phrase "the                                                               
          tax" is used  throughout AS 43.55 as  referring only to                                                               
          the production tax; and                                                                                               
          (2)  AS   43.55.040(1)  deals  only   with  information                                                               
          obtained  from  persons  "engaged  in  production,"  or                                                               
          their agents, and with purchasers  "of oil or gas," and                                                               
          with owners of a "royalty interest in oil or gas."                                                                    
77.  How much  gas  was  flared so  as  to  trigger taxes  and/or                                                               
penalties in recent years?                                                                                                      
   During  FY  2005, 351,000  Mcf  of  gas  was flared  that  was                                                               
   considered  gross taxable  production. Of  that, only  120,000                                                               
   Mcf was  from fields with a  positive ELF and subject  to tax.                                                               
   During the  same period 31,000  Mcf was flared  and considered                                                               
   waste and subject to both tax and penalty.                                                                                   
80. When the 1989 ELF change  was enacted, was it retroactive and                                                               
were there transition provisions?                                                                                               
   The  1989 ELF  changes  were made  retroactive  to January  1,                                                               
   1989, and  applied to  oil produced  after December  31, 1988.                                                               
   There  was  a transition  provision  to  the effect  that  tax                                                               
   payable as  a result of  the retroactive changes would  be due                                                               
   on the 20th day of  the calendar month following the effective                                                               
   date of the Act. (The effective  date of the Act was August 6,                                                               
82. Under  the new  gas and  oil definitions,  what will  the net                                                               
change to the  spill fee be? In other words,  looking at FY 2005,                                                               
how much,  if any (a)  oil did we tax  for its use  in production                                                               
operations and (b) how many NGLS were put in TAPS?                                                                              
   During  FY 2005,  tax was  collected on  1,222,400 barrels  of                                                               
   crude  oil  used in  production  operations.  During FY  2005,                                                               
   16,445,000 barrels of NGLs were put in TAPS.                                                                                 
83. For sales  of credits by the smaller  interests, estimate the                                                               
price at which  those credits will no longer have  a market among                                                               
the big three?                                                                                                                  
   Credits  may  be used  in  the  year of  expenditure,  carried                                                               
   forward  to   following  years,   or  transferred   (they  are                                                               
   fungible).  If   transferred,  the   credit  cannot   lower  a                                                               
   severance  tax  rate  below  80   percent  of  what  it  would                                                               
   otherwise  be  [AS  43.55.024(e)].  These  credits  will  have                                                               
   market value  that would not  exceed 20 percent of  their face                                                               
   value  ($1,000  in capital  expenditures  would  save $200  in                                                               
   State severance  taxes). A company generating  them but unable                                                               
   to use them  would face a choice  - sell them or  use them the                                                               
   following year (if they have taxable income).                                                                                
   Use the  next year  reduces the  value of  the credits  due to                                                               
   discount  rate.  Oil  companies  typically try  to  use  a  15                                                               
   percent discount rate  but will often settle for  less, say 10                                                               
   percent. This  means, all  other things  equal, they  would be                                                               
   willing to sell a  $1,000 credit ($5,000 capital expenditures)                                                               
   for  $900  (10 percent  discount  rate)  or more.  Conversely,                                                               
   another company  would be willing  to pay  up to $999  for the                                                               
   credit to save $1,000 in State severance tax.                                                                                
   If we assume a billion in  spending, assume that 10 percent of                                                               
   that was  for little companies  that would want to  sell their                                                               
   credits, so $200 million in credits  are for sale. With our 20                                                               
   percent  limit, that  implies  that  if the  big  three had  a                                                               
   billion dollar  in tax obligations,  that market  could absorb                                                               
   all the  credits. As our  fiscal note  shows, if the  price of                                                               
   oil is  $40 or above,  all of the  credits would be  usable in                                                               
   the immediate  year. If  oil falls below  $40, then  we expect                                                               
   that the credits  would be fully utilized within  two or three                                                               
   years.  While  the  time-value   of  money  means  that  those                                                               
   certificates  would   be  discounted,  we  believe   that  the                                                               
   certificates would still be marketable.                                                                                      
84. If  aggregation at Prudhoe  Bay had been implemented  on July                                                               
1, 2001 [the start of the  claw back period], how much more would                                                               
the State have  received between then and  the actual aggregation                                                               
   The State would have  received $430.4M additional revenue. She                                                               
   provided a graph of estimates.                                                                                               
85. Why  are the status quo  lines in the three  graphs presented                                                               
by Ms.  Wilson flat  once the forecast  price effect  is adjusted                                                               
for? Wouldn't falling production and ELF move those down?                                                                       
   The status quo drops from $378 mm  in 2009 to $291 mm in 2012.                                                               
   It looks flat because of the scale on the graph.                                                                             
86.  What will  the  actual cost  to the  investor  be for  these                                                               
upstream   investments  and   what   is   the  total   government                                                               
underwriting, state  and federal, all  tax types included.  Is it                                                               
different for large companies and small companies?                                                                              
   After state and federal tax,  the investor would bear about 38                                                               
   percent of the  marginal capital. There is no  reason to think                                                               
   it   would  differ   appreciably  between   large  and   small                                                               
87.  Lord Browne  famously said  two years  ago that  any profits                                                               
over $20  a barrel  were being returned  to shareholders  as they                                                               
weren't  needed in  BP's  business. What  tax  rate, credit  rate                                                               
would be needed to have a  cross over [unspecified period] at $20                                                               
[presumably Brent].                                                                                                             
   With a  20 percent credit, it  would take a tax  rate of about                                                               
   51 percent to affect a crossover at $20 Brent.                                                                               
88. Please explain how the conservation surcharge is affected by                                                                
oil price and what affect this bill has on the surcharge.                                                                       
   a. The  conservation surcharge is  a 3 cent per  barrel charge                                                               
   on all oil  produced less royalty barrels, so  therefore it is                                                               
   not sensitive to price.                                                                                                      
   b. There  will be changes  in the  quantity of oil  subject to                                                               
   both  production tax  and  conservation  surcharges under  the                                                               
   bill. One change will be  positive, one negative. The positive                                                               
   change  is   that  natural  gas   liquids  extracted   by  gas                                                               
   processing and blended  in the TAPS stream that  are now taxed                                                               
   as gas, will be treated as oil under the bill.                                                                               
   The  negative  change  is  that  oil that  is  used  in  lease                                                               
   operations will  not be  taxed or  subject to  surcharge under                                                               
   the bill.  Oil may be used  to make fuel for  lease operations                                                               
   and perhaps  used for other  production purposes.  The overall                                                               
   result is an  expected increase of the  total surcharge amount                                                               
   of $444,000 per year, based  on FY 2005 amounts. (See Question                                                               
   The bill  should not  affect the  assessment or  collection of                                                               
   the   surcharge,  other   than  the   quantity-of-oil  effects                                                               
   described  above. Any  surcharge paid  will be  allowed to  be                                                               
   credited against production taxes,  but that would only reduce                                                               
   the  amount of  tax collected,  not the  amount of  surcharges                                                               
89. Why are we including gas in the PPT calculation?                                                                            
   The bill includes gas in the  PPT calculations because it is a                                                               
   stand-alone  bill. The  bill does  not  require implicitly  or                                                               
   explicitly  that  a  Stranded  Gas  Contract  be  subsequently                                                               
   concluded. Therefore,  a PPT law would  be entirely functional                                                               
   in  case a  Stranded  Gas  Contract is  not  presented to  the                                                               
   Legislature  or  in  case  the   Legislature  rejects  such  a                                                               
   The  ELF  system for  gas  is  "broken"  just  as the  ELF  is                                                               
   "broken" for oil. The gas  ELF does not encourage reinvestment                                                               
   and it is not sensitive to price.                                                                                            
   It  should be  noted that  under high  gas prices,  the Alaska                                                               
   State take  for gas  would increase significantly  relative to                                                               
   the status quo.  This would be beneficial  in case significant                                                               
   gas  reserves would  be  developed outside  the  scope of  the                                                               
   Stranded Gas Development Act.                                                                                                
   The  inclusion  of  gas  in  the PPT  is  therefore  a  strong                                                               
   incentive for  producers to conclude  a Stranded  Gas Contract                                                               
   that is in the interest of  the State of Alaska. Including gas                                                               
   in the PPT  enhances the bargaining position of  the State for                                                               
   a good Stranded Gas Contract.                                                                                                
CHAIR WAGONER thanked everyone for their comments and adjourned                                                                 
the meeting at 5:46:13 PM.                                                                                                    

Document Name Date/Time Subjects