Legislature(2011 - 2012)BUTROVICH 205

04/01/2011 03:30 PM RESOURCES

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03:32:51 PM Start
03:33:20 PM SB49
05:03:56 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
<Above Item Removed from Agenda>
-- Public Comment and Invited Testimony --
Heard & Held
The Following Invited Testimony Only:
Bryan Butcher, DOR, with Focus on the "Oil and
Gas Production Tax Report to the Legislature
(January 18, 2011)"
Kevin Banks, DNR/DOG, with Focus on Leasing and
Royalty Modification
                     ALASKA STATE LEGISLATURE                                                                                 
               SENATE RESOURCES STANDING COMMITTEE                                                                            
                          April 1, 2011                                                                                         
                            3:32 p.m.                                                                                           
MEMBERS PRESENT                                                                                                               
Senator Joe Paskvan, Co-Chair                                                                                                   
Senator Thomas Wagoner, Co-Chair                                                                                                
Senator Bill Wielechowski, Vice Chair                                                                                           
Senator Bert Stedman                                                                                                            
Senator Lesil McGuire                                                                                                           
Senator Hollis French                                                                                                           
Senator Gary Stevens                                                                                                            
MEMBERS ABSENT                                                                                                                
All members present                                                                                                             
OTHER LEGISLATORS PRESENT                                                                                                     
Senator Joe Thomas                                                                                                              
Representative Les Gara                                                                                                         
COMMITTEE CALENDAR                                                                                                            
SENATE BILL NO. 85                                                                                                              
"An Act providing for a tax  credit applicable to the oil and gas                                                               
production tax  based on the cost  of developing new oil  and gas                                                               
production; and providing for an effective date."                                                                               
     - REMOVED FROM AGENDA                                                                                                      
SENATE BILL NO. 49                                                                                                              
"An  Act relating  to  the interest  rate  applicable to  certain                                                               
amounts  due for  fees,  taxes, and  payments  made and  property                                                               
delivered to the  Department of Revenue; relating to  the oil and                                                               
gas  production   tax  rate;  relating  to   monthly  installment                                                               
payments of  estimated oil  and gas  production tax;  relating to                                                               
oil  and gas  production  tax credits  for certain  expenditures,                                                               
including    qualified   capital    credits   for    exploration,                                                               
development,  and  production;  relating  to  the  limitation  on                                                               
assessment  of oil  and  gas production  taxes;  relating to  the                                                               
determination  of  oil  and gas  production  tax  values;  making                                                               
conforming amendments; and providing for an effective date."                                                                    
     - HEARD & HELD                                                                                                             
PREVIOUS COMMITTEE ACTION                                                                                                     
BILL: SB  49                                                                                                                  
SHORT TITLE: PRODUCTION TAX ON OIL AND GAS                                                                                      
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
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WITNESS REGISTER                                                                                                              
BRIAN BUTCHER, Commissioner Designee                                                                                            
Department of Revenue                                                                                                           
Anchorage, AK                                                                                                                   
POSITION STATEMENT:  Discussed the Oil and Gas Production Tax                                                                 
Status Report as it related to SB 49.                                                                                           
BRUCE TANGEMAN, Deputy Commissioner                                                                                             
Department of Revenue                                                                                                           
Anchorage, AK                                                                                                                   
POSITION STATEMENT:  Offered information related to the Oil and                                                               
Gas Production Tax Status Report as it related to SB 49.                                                                        
KEVIN BANKS, Director                                                                                                           
Division of Oil and Gas                                                                                                         
Department of Natural Resources                                                                                                 
Anchorage, AK                                                                                                                   
POSITION  STATEMENT:    Discussed  North Slope  leasing  and  the                                                             
state's royalty modification program as it related to SB 49.                                                                    
ACTION NARRATIVE                                                                                                              
3:32:51 PM                                                                                                                    
CO-CHAIR  JOE  PASKVAN  called   the  Senate  Resources  Standing                                                             
Committee meeting  to order at 3:32  p.m. Present at the  call to                                                               
order  were  Senators  French,  Stevens,  Stedman,  Wielechowski,                                                               
Wagoner, and Paskvan.                                                                                                           
               SB  49-PRODUCTION TAX ON OIL AND GAS                                                                         
3:33:20 PM                                                                                                                    
CO-CHAIR  PASKVAN  announced  the  consideration of  SB  49,  and                                                               
informed the committee  that Bryan Butcher would  discuss the Oil                                                               
and  Gas  Production Tax  Status  Report  and Kevin  Banks  would                                                               
discuss North Slope leasing and  the state's royalty modification                                                               
program. He  asked Mr. Butcher to  begin with an overview  of the                                                               
Alaska's  Clear and  Equitable Share  (ACES)  Status Report,  and                                                               
then walk  through the  executive summary,  focusing on  each key                                                               
finding. Before transitioning to Mr.  Banks, he said he'd like to                                                               
know if DOR  performed an economic analysis  when it contemplated                                                               
a production tax reduction, similar  to the one DNR conducted for                                                               
royalty  modification.  He  asked   for  an  explanation  of  the                                                               
decision, and  if it would be  in the best interest  of the state                                                               
to do that  sort of analysis considering the  potential impact of                                                               
SB 49.                                                                                                                          
BRIAN  BUTCHER,  Commissioner  Designee, Department  of  Revenue,                                                               
stated that the  Oil and Gas Production Tax Status  Report to the                                                               
Legislature is  required under AS  43.55.180 as part of  the 2006                                                               
Petroleum Profits Tax (PPT) legislation.                                                                                        
3:36:24 PM                                                                                                                    
SENATOR MCGUIRE joined the committee.                                                                                           
COMMISSIONER BUTCHER provided the  following overview of the ACES                                                               
status  report,  which  evaluates  six elements  of  the  state's                                                               
production tax system.                                                                                                          
   1. Revenue Generation/Tax Rate - Revenues under PPT and ACES                                                                 
      exceeded the  amount  that the  state  would have  received                                                               
      under the  Economic Limit  Factor  (ELF) each  of the  four                                                               
      fiscal years since  a net profits  tax was  implemented. He                                                               
      noted the  PowerPoint includes  a chart  that compares  the                                                               
      three tax systems.                                                                                                        
CO-CHAIR  PASKVAN  noted  that   the  explanation  also  includes  the                                                          
statement that  the production tax rate  under ACES may be  as high as                                                          
75 percent. He asked if that  is a nominal, marginal, or effective tax                                                          
COMMISSIONER BUTCHER answered it's a nominal tax rate.                                                                          
CO-CHAIR PASKVAN asked what the price is for crude oil at that rate.                                                            
COMMISSIONER BUTCHER said he would  follow up with specifics, but that                                                          
is the cap under the original ACES legislation.                                                                                 
   2. Industry Investment - Capital expenditures have increased                                                                 
      each of the four fiscal years since the net profits tax was                                                               
      implemented. However,  it is  not clear  how much  of those                                                               
      capital expenditures were drilling or  well-related and how                                                               
      much were maintenance or facilities-related.  He noted that                                                               
      the committee previously  discussed that  DOR will  need to                                                               
      implement regulations to  gather additional  information so                                                               
      as  to  definitively  know  what  that   breakdown  is.  He                                                               
      acknowledged that it's an area that needs improvement.                                                                    
CO-CHAIR  PASKVAN asked  if  he  knew whether  or  not  the major  oil                                                          
companies were rebuilding infrastructure at Prudhoe Bay.                                                                        
COMMISSIONER BUTCHER replied  he didn't have specifics,  but he's sure                                                          
that   considerable  work   is  being   done  to   keep  that   mature                                                          
infrastructure going and safe.                                                                                                  
CO-CHAIR  PASKVAN  asked  if  it's  fair to  assume  that  if  capital                                                          
expenditures  are not  going into  well-related activities,  then they                                                          
are likely going into infrastructure rejuvenation at Prudhoe Bay.                                                               
COMMISSIONER BUTCHER replied  that is one area where  that is probably                                                          
taking place.                                                                                                                   
BRUCE  TANGEMAN,  Deputy   Commissioner,  Department  of  Revenue                                                               
(DOR),  referenced  the earlier  question  about  the 75  percent                                                               
nominal production tax  rate, and explained that is  the top rate                                                               
in a production tax value (PTV) of $342.50.                                                                                     
SENATOR WIELECHOWSKI asked what the nominal and effective tax                                                                   
rates would be when oil is $100/barrel.                                                                                         
MR.  TANGEMAN offered  to  follow up  with  precise numbers,  but                                                               
generally it's about $30 in transportation costs.                                                                               
COMMISSIONER BUTCHER continued to review the elements of the state's                                                            
production tax system.                                                                                                          
   3. Impact on Exploration, Development, and Production -                                                                      
      Exploration  generally  increased  after   2003,  when  the                                                               
      Exploration Incentive  Credit  (EIC)  was implemented,  but                                                               
      dropped  off  in   2010  and  2011.   Although  development                                                               
      continues in  three relatively  new  North Slope  projects,                                                               
      production continues to decline.                                                                                          
   4. Industry Employment and New Entrants - Industry employment                                                                
     rose steadily between 2006 and 2009, but dipped slightly in                                                                
CO-CHAIR PASKVAN asked what that signifies.                                                                                     
COMMISSIONER BUTCHER replied that's simply the information that DOR                                                             
3:43:28 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if  in 2004  and 2005,  roughly 8,000                                                               
people were working in the oilfields.                                                                                           
COMMISSIONER BUTCHER answered yes.                                                                                              
SENATOR WIELECHOWSKI asked if the tax  rate at that time was zero                                                               
percent on at least 15 of 19 fields.                                                                                            
COMMISSIONER BUTCHER answered yes.                                                                                              
SENATOR  WIELECHOWSKI recapped  that there  were 8,000  jobs when                                                               
the tax  rate was zero, and  he understands that last  year there                                                               
were 12,800 jobs on the North Slope.                                                                                            
COMMISSIONER BUTCHER agreed, and added  that the largest spike in                                                               
jobs occurred  in 2006 when corrosion  became a big issue  on the                                                               
North  Slope.  Job  numbers  increased by  1,400  that  year  and                                                               
continued the next couple of years.                                                                                             
MR. TANGEMAN pointed  out that the price of oil  in 2003/2004 was                                                               
between $30 and $40 per barrel.  In 2008 the price spiked to well                                                               
over $100 per barrel.                                                                                                           
SENATOR  WIELECHOWSKI  said  his  understanding is  that  as  the                                                               
production  tax rate  on the  North Slope  was declining  towards                                                               
zero from 2001 to 2003, job  numbers on the North Slope were also                                                               
declining. He asked if that was his understanding as well.                                                                      
COMMISSIONER  BUTCHER replied  job numbers  bounced up  and down,                                                               
but definitely trended down.                                                                                                    
3:45:26 PM                                                                                                                    
CO-CHAIR  PASKVAN  said a  lot  of  people that  were  previously                                                               
employed in  the oilfields are  questioning why so  many Alaskans                                                               
aren't working when total numbers in the oil industry are up.                                                                   
COMMISSIONER  BUTCHER agreed  it's a  contradiction, but  DOR has                                                               
not received  detailed information  from the Department  of Labor                                                               
and Workforce Development (DOLWD) as to why this is occurring.                                                                  
CO-CHAIR  PASKVAN  asked if  there  was  a potential  correlation                                                               
between the numbers of resident versus nonresident hires.                                                                       
COMMISSIONER  BUTCHER  replied   the  breakdown  on  unemployment                                                               
claimants  indicates that  both residents  and non-residents  are                                                               
affected.  He  didn't  have  the breakdown  of  the  North  Slope                                                               
employment numbers for residents and nonresidents.                                                                              
CO-CHAIR  PASKVAN   asked  if  people   from  the   Interior  who                                                               
previously worked in the oil  industry have a valid concern about                                                               
nonresident  hires in  light of  the fact  that their  employment                                                               
numbers are down when overall employment numbers are up.                                                                        
COMMISSIONER  BUTCHER  replied he,  too,  has  that concern,  but                                                               
until  DOR gets  a breakdown  from  the Department  of Labor  and                                                               
Workforce Development  (DOLWD), he  can't dig  in and  figure out                                                               
what is really going on.                                                                                                        
SENATOR FRENCH  said at  some point  he'd like  to hear  from Mr.                                                               
CO-CHAIR  PASKVAN  noted for  the  record  that Neal  Fried  with                                                               
DOLWD, Kevin  Banks with  DNR, and  Lennie Dees,  Cheryl Nienhuis                                                               
and John Larsen with DOR were online to answer questions.                                                                       
SENATOR FRENCH asked  Mr. Fried if he had an  explanation for the                                                               
apparent  contradiction  between   DOLWD's  most  recent  numbers                                                               
indicating record  high employment  on the  North Slope,  and the                                                               
volume   of  individual   testimony  about   layoffs  and   force                                                               
MR.  NEAL FRIED,  Economist, Department  of  Labor and  Workforce                                                               
Development  (DOLWD),  said part  of  the  difficulty comes  from                                                               
looking at  the annual averages  instead of the monthly  data. In                                                               
2008, 2009,  and 2010, annual  average employment  was relatively                                                               
stable, but the monthly data shows a lot more volatility.                                                                       
In 2009, employment  for oil and gas peaked at  about 13,500, but                                                               
by  November  that  number  had  dropped  to  11,988.  Employment                                                               
drifted down  over the course of  the year, and at  the same time                                                               
the  number of  unemployment  claims increased  between 2008  and                                                               
2009. In  2010, employment stabilized  in the first  quarter then                                                               
grew through the third quarter,  while unemployment claims in the                                                               
oil industry drifted  down. Between 2008 and 2009,  the number of                                                               
unemployment  claimants in  the oil  and gas  industry went  from                                                               
about 1,400  to about 2,700 and  then dropped to about  2,500 the                                                               
following  year. There's  a lot  more volatility  month-to-month,                                                               
quarter-to-quarter than on the average annual basis, he said.                                                                   
3:52:54 PM                                                                                                                    
CO-CHAIR  PASKVAN  asked  him  to  explain  the  context  of  his                                                               
statement that  "The oil industry  has been able to  perform more                                                               
work using fewer workers."                                                                                                      
MR. FRIED said he wasn't sure.                                                                                                  
CO-CHAIR PASKVAN asked if he  generally believes the statement to                                                               
be accurate.                                                                                                                    
MR.  FRIED reiterated  that  he  would need  to  see the  context                                                               
within which he made that statement.                                                                                            
SENATOR  WIELECHOWSKI asked  if the  BP corrosion  work ended  in                                                               
MR. FRIED replied he couldn't pinpoint the time.                                                                                
SENATOR WIELECHOWSKI  asked if he  had a breakdown of  the number                                                               
of residents versus nonresidents filing for unemployment.                                                                       
MR.  FRIED  said  in  2008, the  number  of  residents  receiving                                                               
unemployment  that were  tied to  the  oil and  gas industry  was                                                               
about 1,200, and  increased to about 2,200 in 2009.  In that same                                                               
data  set, nonresident  numbers  increased from  154  in 2008  to                                                               
almost  500 in  2009.  Resident numbers  doubled and  nonresident                                                               
numbers  almost tripled.  In 2010,  resident  numbers dropped  to                                                               
about 2,100  and nonresident  numbers stayed  about the  same. He                                                               
added  that  there  is  a  certain  amount  of  churning  in  the                                                               
oilfields as  contracts come and  go, even if  overall employment                                                               
doesn't change much.                                                                                                            
MR.  FRIED summarized  that the  large  increase in  unemployment                                                               
numbers between  2008 and  2009 was  due to  the job  losses that                                                               
took place  during the latter  part of 2009. Those  numbers began                                                               
to recover in 2010 and unemployment claims began to drop.                                                                       
SENATOR WIELECHOWSKI asked if the  2,200 residents that filed for                                                               
unemployment  in 2009  are  new  people filing  or  if the  1,200                                                               
residents that filed in 2008 are included.                                                                                      
MR. FRIED  replied it's  hard to  tell, but  he would  guess that                                                               
there was both overlap and new claimants.                                                                                       
3:58:09 PM                                                                                                                    
SENATOR MCGUIRE  asked if  DOLWD had ever  collected oil  and gas                                                               
industry  data that  more clearly  defined  work categories  like                                                               
drilling, transportation,  catering and other companies  that are                                                               
directly involved in the oil industry.                                                                                          
MR.  FRIED  replied  the  definitions are  specific  to  the  oil                                                               
industry, which  means they exclude  people that are  involved in                                                               
transportation or  catering, despite the fact  that those players                                                               
also directly  work in the  oilfield. He explained that  a number                                                               
of years  ago, DOLWD looked at  Prudhoe Bay and found  that about                                                               
25 percent of the employment  that was generated in the oilfields                                                               
was from non-oilfield employers.  They weren't drilling companies                                                               
like Schlumberger,  ConocoPhillips, CHMHill,  or  Doyon Drilling.                                                               
He  said  it's difficult  for  DOLWD  to separate  those  non-oil                                                               
industry employers because a lot  of those players (the catering,                                                               
transportation and  construction companies) are also  involved in                                                               
activity  elsewhere in  the state  and  in other  sectors of  the                                                               
4:01:12 PM                                                                                                                    
SENATOR MCGUIRE asked if DOLWD  data delineates the categories of                                                               
activities  to maintain  existing  infrastructure  as opposed  to                                                               
activities  that   are  specifically  related  to   oil  and  gas                                                               
MR. FRIED  answered no. DOLWD  does break out oil  producers from                                                               
oilfield service  companies, but not the  activity of exploration                                                               
versus maintenance. Most  of the North Slope  employers work both                                                               
sides  so there  is no  way of  knowing if  they are  involved in                                                               
maintenance activity or exploration activity.                                                                                   
CO-CHAIR PASKVAN asked  if the definition had changed  in last 6-                                                               
10 years.                                                                                                                       
MR.  FRIED  answered  no;  there   had  been  no  change  in  the                                                               
definition of  the oil  industry and  the oil  industry employers                                                               
that fall within that category.                                                                                                 
SENATOR  WIELECHOWSKI said  the jobs  issue is  critical, and  at                                                               
some  point  he'd  like  a  deeper analysis  to  figure  out  why                                                               
employment on the  North Slope is at a record  high, yet Alaskans                                                               
are saying  they've lost  their jobs. Between  2008 and  2009 the                                                               
Alaskan  unemployment  rate nearly  doubled  so  this is  a  good                                                               
discussion to have, he stated.                                                                                                  
CO-CHAIR  PASKVAN  reiterated  the  committee's  extreme  concern                                                               
about  the apparent  conflict between  overall employment  versus                                                               
resident employment numbers on the North Slope.                                                                                 
4:04:46 PM                                                                                                                    
 COMMISSIONER BUTCHER continued the presentation.                                                                               
   5. Use and Expansion of Tax Credits - The amount of credits                                                                  
      used has increased  annually since 2006  and that  trend is                                                               
      expected to  continue,  because  new credit  programs  were                                                               
      added during the  2010 legislative  session. He  noted that                                                               
      DOR continues to  look at how  effective those  tax credits                                                               
CO-CHAIR   PASKVAN    observed   that   the    "Conclusions   and                                                               
Recommendations"   section  of   status   reports  includes   the                                                               
statement that  "it is untenable  to blame  a tax system  for the                                                               
lack of  industry investment." He  asked Commissioner  Butcher to                                                               
COMMISSIONER  BUTCHER replied  that sentence  continues to  state                                                               
that, "it  is equally untenable to  claim that the tax  system is                                                               
the  reason   increased  activity   or  investment   occurs."  He                                                               
explained  that   the  point  is  that   industry  investment  is                                                               
dependent on  many factors, and  changing just one  element won't                                                               
solve all the problems.                                                                                                         
CO-CHAIR PASKVAN  said he  was trying  to square  that qualifying                                                               
statement  with  Commissioner  Galvin's  January  14,  2010  ACES                                                               
status report that  indicated that ACES was performing  as it was                                                               
expected  to  perform  when  it  passed  in  2007.  The  economic                                                               
provisions resulted  in the anticipated  revenue levels,  and the                                                               
investment incentives  appeared to  distribute the  increased tax                                                               
burden in a manner that continued to encourage investment.                                                                      
4:07:19 PM                                                                                                                    
COMMISSIONER BUTCHER  responded the  current status  report looks                                                               
at information that is one  year beyond where Commissioner Galvin                                                               
was looking.  At the beginning  of 2010  his team might  not have                                                               
been  aware that  only four  exploration wells  would be  drilled                                                               
(two  of which  would be  delineation wells),  and that  just one                                                               
exploration well  would be drilled  in 2011. He also  didn't know                                                               
that the result would be a spike in the price of oil.                                                                           
SENATOR WIELECHOWSKI said DOR's conclusion  just one year ago was                                                               
that   the  investment   incentive   provisions   in  ACES   were                                                               
contributing  to  increased  levels   of  expenditure.  He  asked                                                               
Commissioner Butcher  if he  was saying that  he had  evidence to                                                               
the contrary.                                                                                                                   
COMMISSIONER  BUTCHER confirmed  that  there  had been  increased                                                               
spending  since ACES  passed, and  added that  there was  already                                                               
increased spending  before both  ACES and  PPT passed.  He opined                                                               
that  since  the  slope  was  already  increasing,  it  would  be                                                               
difficult to say  that the increase was due to  passage of either                                                               
tax legislation.                                                                                                                
SENATOR WIELECHOWSKI asked if he  believes that the $3 billion in                                                               
tax credits  led to any  increased investment or  exploration, or                                                               
that it should be scrapped.                                                                                                     
COMMISSIONER BUTCHER  answered the changes made  in ACES resulted                                                               
in  a lot  of new  companies and  smaller independents  coming to                                                               
Alaska.  There  are   many  positive  aspects  to   ACES  and  it                                                               
definitely  should not  be scrapped.  However, the  new companies                                                               
have indicated  ongoing difficulty  getting the  larger companies                                                               
to  move  from exploration  to  production  as  a result  of  the                                                               
progressivity  tax.   That  is   the  focus  of   the  governor's                                                               
SENATOR   WIELECHOWSKI  said   he  finds   it  implausible   that                                                               
exploration  companies  would  come  to  Alaska  and  spend  huge                                                               
amounts of money  to buy leases and explore  before analyzing the                                                               
potential costs, profits and taxes under ACES.                                                                                  
COMMISSIONER BUTCHER suggested he  ask the companies specifically                                                               
what they look at in those  situations. He noted that Savant, for                                                               
example, last  year testified  that they  loved the  credits, but                                                               
had difficulty getting partners to move on to production.                                                                       
4:11:18 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if  the administration  believes that                                                               
it is helping the investment climate  when it says that Alaska is                                                               
closed for business; the tax rates  are too high and the state is                                                               
COMMISSIONER BUTCHER  responded the administration is  not saying                                                               
that Alaska  is closed for  business. There are many  tax credits                                                               
that   make   investment   in    Alaska   attractive,   but   the                                                               
administration believes  the tax needs  to be adjusted.  In part,                                                               
this belief is based on  conversations the administration has had                                                               
with the companies  that have come to Alaska or  those that would                                                               
like to come.                                                                                                                   
CO-CHAIR PASKVAN asked Commissioner Butcher to address point 6.                                                                 
COMMISSIONER BUTCHER continued.                                                                                                 
   6. Tax Administration and Compliance - DOR continues to write                                                                
      regulations for the new  tax system. The last  audits under                                                               
      PPT have been completed and the first audits under ACES are                                                               
      underway. DOR believes that most of the work that needed to                                                               
      be done to change  from a gross tax  to a net tax  has been                                                               
      done, and  the  expectation  is  that  the audits  will  be                                                               
      accelerated thereafter. However,  DOR has been  hampered in                                                               
      its tax reporting and  compliance efforts by the  lack of a                                                               
      centralized database in which to house and manage the large                                                               
      volumes of oil  and gas  data. This  slows the  process and                                                               
      limits output.                                                                                                            
CO-CHAIR PASKVAN summarized that the  state is slow in processing                                                               
the data  it receives and, in  part, that is the  reason that DOR                                                               
is  unable to  provide  answers  as to  whether  or  not the  tax                                                               
credits are working to promote investment.                                                                                      
COMMISSIONER BUTCHER  responded that doesn't help,  but it's also                                                               
a matter of not having passed  regulations that would help to get                                                               
more definitive numbers from the  industry. He reiterated that he                                                               
wasn't aware of that prior  to becoming commissioner, but getting                                                               
that information is a focus going forward.                                                                                      
CO-CHAIR PASKVAN  noted that  Senator Joe  Thomas had  joined the                                                               
4:15:03 PM                                                                                                                    
SENATOR  WIELECHOWSKI noted  that  the  legislative audit  report                                                               
found significant  issues related  to the  auditing of  ACES, and                                                               
asked if  he still  supported reducing  the timeframe  to perform                                                               
those audits from six years to four years.                                                                                      
COMMISSIONER   BUTCHER  replied   the   administration  is   very                                                               
comfortable  that  the  audits  could  be  done  in  the  shorter                                                               
timeframe, but  leaving it at  six years is also  acceptable. The                                                               
provision  addresses the  difficulty associated  with hiring  and                                                               
keeping  good auditors  and, while  the situation  is better  now                                                               
than a year ago, it is still an issue.                                                                                          
SENATOR  STEVENS  asked  if  it was  possible  to  contract  with                                                               
independent firms to do the auditing.                                                                                           
COMMISSIONER BUTCHER  offered to follow up  with specific details                                                               
about the  times in  the last  few years that  DOR has  relied on                                                               
CO-CHAIR  PASKVAN asked  what type  of  industry information  was                                                               
missing  from the  DOR database  and if  those significant  holes                                                               
should be addressed in statute or regulation.                                                                                   
COMMISSIONER  BUTCHER   replied  DOR   doesn't  get   a  detailed                                                               
breakdown from industry  on capital and operating  expenses so as                                                               
to know what  is going into exploratory  versus maintenance work.                                                               
However, DOR  has the regulatory  authority to get  more detailed                                                               
information, and  will probably  pursue it after  the end  of the                                                               
legislative  session.  He  noted that  the  extensive  regulation                                                               
process that  occurred during  ACES focused  on an  open workshop                                                               
process   that    encouraged   participation    from   producers,                                                               
legislators  and   any  other   interested  parties.   That  same                                                               
invitation will go out for the upcoming process, he stated.                                                                     
4:19:35 PM                                                                                                                    
MR.  TANGEMAN added  that there  are  two issues.  First is  what                                                               
information DOR is getting and how  they get it. Second is how to                                                               
handle  the information.  The change  from gross  tax to  net tax                                                               
resulted in  a huge amount  of additional information  coming in,                                                               
and the  existing standalone systems  have difficulty  keeping up                                                               
with the  influx. He  said it's often  necessary to  page through                                                               
documents  by  hand  to  respond   to  legislative  requests  for                                                               
SENATOR  WIELECHOWSKI  asked  for   the  timeline  for  when  the                                                               
legislature could expect to see  the regulations. He reminded the                                                               
commissioner that it was more  than three years ago that Gaffney,                                                               
Cline &  Associates highlighted that Alaska  didn't have anywhere                                                               
near the information that other  sovereign jurisdictions had, and                                                               
reinforced that point  again this year. Their  testimony was that                                                               
Alaska  is handicapped  in making  decisions  about its  economic                                                               
future because it  doesn't have the data necessary  to manage its                                                               
resource like a landowner.                                                                                                      
COMMISSIONER BUTCHER  responded that  it was a  personal priority                                                               
and he would like to start the process this summer.                                                                             
MR. TANGEMAN  added that DOR  was substantially caught up  on the                                                               
regulatory work it had done the  last several years and was ready                                                               
to  look  at  what  was   needed  and  getting  those  additional                                                               
regulations in place.                                                                                                           
SENATOR  MCGUIRE  suggested  that  this  was  an  opportunity  to                                                               
develop  a  robust and  detailed  database  that could  last  for                                                               
institutional generations.  She opined that Alaska  should be the                                                               
number one oil  and gas jurisdiction in the U.S.,  and its fiscal                                                               
system should be  able to move on  a dime to respond  to needs as                                                               
they arise.  Data should  be readily available  to show  when and                                                               
why adjustments should be made, she stated.                                                                                     
4:25:09 PM                                                                                                                    
CO-CHAIR PASKVAN asked who authored the January 18, 2011 report.                                                                
COMMISSIONER  BUTCHER  replied  it   was  a  joint  process  that                                                               
included work from  Bruce Tangeman, Cheryl Nienhuis,  most of the                                                               
economics team, and himself.                                                                                                    
MR. TANGEMAN added that they  relied heavily on the DOR petroleum                                                               
economists and then put the report together.                                                                                    
CO-CHAIR  PASKVAN asked  Commissioner Butcher  if the  report was                                                               
put together after he became commissioner designee.                                                                             
COMMISSIONER BUTCHER replied he had  an impact on the report, but                                                               
it was already in a preliminary form  as it was due 14 days after                                                               
he started.                                                                                                                     
SENATOR STEDMAN  commented that  the single  point audit  and the                                                               
marked deficiencies caught a lot  of attention at the Legislative                                                               
Budget and  Audit meeting,  and that  information has  since been                                                               
released  to  the public  so  there  are  no surprises.  He  then                                                               
highlighted that the  FY12 budget did not include  a request from                                                               
the governor to put the database  in place, despite the fact that                                                               
legislators are  being asked  this winter to  come to  a decision                                                               
about the tax system and they need  more data points to come to a                                                               
proper conclusion. He  reported that rather than  waiting for the                                                               
next  budget  cycle,  the legislature  was  stepping  forward  to                                                               
address this  situation by including  about $34.7 million  in the                                                               
capital  budget  for  the purchase  and  implementation  of  that                                                               
system.  He said  there have  already been  discussions with  the                                                               
commissioner to identify that amount,  so the department won't be                                                               
taken by  surprise. He  emphasized that  the legislature  will do                                                               
everything  possible from  a policy-making  standpoint to  ensure                                                               
that  DOR  has  the  funds   available  to  protect  the  state's                                                               
interest.  He stated  that he  and  other policy  makers are  not                                                               
comfortable that  the most  recent audit  was conducted  in 2006,                                                               
and   opined  that   the  administration   also  would   be  more                                                               
comfortable with a more timely audit.                                                                                           
4:28:47 PM                                                                                                                    
CO-CHAIR PASKVAN  segued to the  royalty modification  issue, and                                                               
asked if DOR performed an  economic analysis when it contemplated                                                               
a production tax  reduction similar to what DNR  performs when it                                                               
does a royalty reduction.                                                                                                       
COMMISSIONER  BUTCHER  replied  he  couldn't  speak  to  the  DNR                                                               
program, but  he could say  that DOR's process was  underway with                                                               
both DNR and the governor's office  in January when he started as                                                               
commissioner. In that  process, DOR looked at  numbers, talked to                                                               
companies and gathered  as much information as  possible in order                                                               
to make the decision to move forward.                                                                                           
CO-CHAIR PASKVAN  pointed out  that the report  on the  DNR model                                                               
indicates  that it  describes  project  cash flows;  incorporates                                                               
fiscal  system attributes  including  state/federal taxes,  state                                                               
production tax, and royalty obligations;  includes the metrics of                                                               
annual  and cumulative  discounted and  undiscounted cash  flows;                                                               
years to  payout net present  value, expected monetary  value and                                                               
internal rate of return on  investment as well as state revenues.                                                               
He asked  if DOR intended  to provide any  comparable information                                                               
to the legislature with respect to a production tax reduction.                                                                  
COMMISSIONER  BUTCHER replied  DOR worked  with DNR  and spent  a                                                               
great deal  of time  "tweaking with  brackets, with  no brackets,                                                               
taking  a look  at what  ... the  shifts in  share would  be." He                                                               
offered to  follow up and show  DOR's various models that  can be                                                               
manipulated to  show different scenarios.  He reiterated  that he                                                               
would need to  become more familiar with the DNR  model before he                                                               
could specify both similarities and dissimilarities.                                                                            
CO-CHAIR PASKVAN  asked if the  overall debate would  be enhanced                                                               
if DOR  were to  perform a  similar process  to find  things like                                                               
internal rates of  return, expected cash values and  years to pay                                                               
COMMISSIONER  BUTCHER  opined  that more  information  is  always                                                               
beneficial, but  there will always  be more information  that one                                                               
could have.                                                                                                                     
MR. TANGEMAN  pointed out that the  royalty modification analysis                                                               
is done  on a field-by-field basis,  whereas DOR is looking  at a                                                               
production tax modification for the state as a whole.                                                                           
SENATOR  STEDMAN  asked if  DOR  would  conduct a  field-by-field                                                               
analysis to  set up  a fiscal system  for a new  basin or  if the                                                               
analysis would cover the entire basin.                                                                                          
MR. TANGEMAN responded the information  such as internal rates of                                                               
return  would be  of value,  but his  understanding was  that DOR                                                               
doesn't  have  those  details.  A lot  of  the  information  that                                                               
companies  base their  decisions  on is  proprietary and  limited                                                               
with regard to what is shared with the department.                                                                              
SENATOR STEDMAN  observed that rate of  return style calculations                                                               
are done all over the world, and  asked if DOR had ever looked at                                                               
those  when it  considered things  like modifying  a base  tax or                                                               
changing progressivity.                                                                                                         
COMMISSIONER BUTCHER  responded DOR  has looked  at that  sort of                                                               
information, but it  was very much an estimate and  there were so                                                               
many  differences that  it  was difficult  to  make any  specific                                                               
comparison between Alberta or Nigeria or Alaska, for example.                                                                   
4:35:16 PM                                                                                                                    
SENATOR  STEDMAN  asked if  DOR  runs  calculations to  determine                                                               
rates  of return,  present values,  and expected  monetary values                                                               
when  it suggests  changing  the state's  fiscal  system from  25                                                               
percent to 15 percent base tax, for example.                                                                                    
COMMISSIONER BUTCHER  responded DOR  used all the  information it                                                               
had  when  it  ran  the  different analyses,  but  that  kind  of                                                               
detailed information was limited. He  offered his belief that DNR                                                               
receives much  more detailed information  in the  royalty program                                                               
because companies have to prove whether  or not the area would be                                                               
economic based on the royalty.                                                                                                  
SENATOR STEDMAN  pointed out  that the state  has the  ability to                                                               
grant royalty relief, and questioned  why there wasn't a flood of                                                               
royalty  relief  questions  when  the royalty  ranges  from  12.5                                                               
percent to 16.5 percent. He  explained for the listening audience                                                               
that the  royalty comes  off the  gross value  coming out  of the                                                               
ground, so changing it has a huge impact.                                                                                       
COMMISSIONER BUTCHER  suggested that Kevin Banks  could provide a                                                               
more complete  answer, but his  understanding was that  just four                                                               
developments considered  that the  economics of the  field hinged                                                               
on  the royalty.  Two  of those  were turned  down  and two  were                                                               
worked out with the department.                                                                                                 
SENATOR WIELECHOWSKI  stated agreement with the  notion that more                                                               
information is better, and observed  that a problem with the bill                                                               
was that it had virtually  no information that would cause anyone                                                               
to believe that  it would lead to extra production  or more jobs.                                                               
He said  we know  there was  a six percent  decline when  the tax                                                               
rate was zero percent on 75  percent of the fields; that jobs are                                                               
at  all-time highs,  that capital  expenditures  are at  all-time                                                               
highs,  that operating  expenditures are  at all-time  highs, and                                                               
that the  North Slope  now has  twice as  many producers.  But we                                                               
don't  know why  jobs  are  being lost;  how  the incentives  are                                                               
working;  which  fields  are  marginal;   which  fields  will  be                                                               
incentivized if SB  49 passes; how much more  exploration will be                                                               
incentivized; which fields  meet hurdle rates; if  this bill will                                                               
cause a single  drop of oil to  be put into the  pipeline; if any                                                               
Alaskans will be hired if the  bill passes; if a single well will                                                               
be drilled if  the bill is passed; what the  company hurdle rates                                                               
are; what their  net present value rates are  for certain fields;                                                               
what the internal rates of return  are for certain fields; or how                                                               
much profit  Exxon makes  in this state.  He emphasized  that the                                                               
legislature  needs a  lot more  information  in order  to make  a                                                               
decision on what will cost the  state from $7-10 billion over the                                                               
next five years.                                                                                                                
COMMISSIONER  BUTCHER responded  that  oil  continues to  decline                                                               
more  than the  department's annual  revenue forecast,  and there                                                               
seems  to  be  almost  no  exploration when  oil  prices  are  at                                                               
historic  highs  and boons  are  going  on  all over  the  world.                                                               
Companies have come forward and testified  that SB 49 will make a                                                               
material difference  and while  there have  been no  promises DOR                                                               
believes that to be the case.  He pointed out that there was next                                                               
to no information with PPT changing  from a gross tax, and then a                                                               
year later PPT was changed to  ACES. DOR gathers and analyzes the                                                               
information it gets and then makes a decision, he stated.                                                                       
SENATOR  STEDMAN  highlighted that  the  FY12  fall forecast  had                                                               
about $5.5  billion going to the  state and $2.4 billion  of that                                                               
was  royalties. He  pointed out  that it's  not necessary  to run                                                               
through  the math  model to  see that  changing the  royalty rate                                                               
will result  in a huge  material difference. Obviously,  they are                                                               
very significant.                                                                                                               
4:42:09 PM                                                                                                                    
COMMISSIONER BUTCHER  responded that  he didn't intend  to convey                                                               
that the issue wasn't important. He  added that DNR has said that                                                               
it is  a piece that  is more difficult to  prove as to  whether a                                                               
field is economic or not economic.                                                                                              
SENATOR  STEDMAN  observed  that  one of  the  questions  is  why                                                               
industry  isn't coming  forward  and asking  for relief,  because                                                               
requests were made and granted in the past.                                                                                     
MR. TANGEMAN  suggested he  ask Mr.  Banks when  DNR can  enter a                                                               
royalty relief negotiation. He offered  his understanding that it                                                               
is  before  a   field  comes  on  line,   not  necessarily  after                                                               
production starts.                                                                                                              
CO-CHAIR  WAGONER  asked  if anyone  looked  at  a  carry-forward                                                               
credit  tied to  an increase  in  production, and  the amount  of                                                               
deduction  the governor  wants  to provide  to  the legacy  field                                                               
COMMISSIONER BUTCHER  responded that DOR  would be happy  to talk                                                               
about  any issue  that would  facilitate the  governor's goal  of                                                               
more  production.  He assured  the  committee  that the  governor                                                               
would be willing to discuss any beneficial ideas.                                                                               
CO-CHAIR WAGONER  asked if  he had information  on the  number of                                                               
well workovers that had been done and the result.                                                                               
COMMISSIONER BUTCHER replied AOGCC  delivered that information to                                                               
House Finance  several weeks ago  and will probably  include that                                                               
information in  their presentation  to this committee  next week,                                                               
but DOR can also provide it.                                                                                                    
CO-CHAIR PASKVAN  thanked Commissioner  Butcher and  Mr. Tangeman                                                               
and again  emphasized the importance  of modeling and  a detailed                                                               
analysis  to  determine  if  modifying the  lease  terms  for  an                                                               
applicant  would or  would  not  result in  the  state giving  up                                                               
revenue for no reason.                                                                                                          
4:46:51 PM                                                                                                                    
KEVIN BANKS,  Director, Division  of Oil  and Gas,  Department of                                                               
Natural  Resources  (DNR),  stated  that  the  issue  is  royalty                                                               
modification, and that is governed by AS 38.05.180(j).                                                                          
He  explained  that  the  DNR commissioner  has  always  had  the                                                               
statutory  authority for  royalty modification,  but until  about                                                               
1996  it  could only  be  used  for  fields  that fell  into  two                                                               
categories: 1) to  prolong the economic life of a  field that was                                                               
about to be shut in because  the operating costs had exceeded the                                                               
operating  revenues,  or  2)  to  allow  lessees  to  reestablish                                                               
production from a shut-in field.  In both cases, royalty could be                                                               
reduced to as little as three percent.                                                                                          
A  third category  was  added in  1996 to  the  authority of  the                                                               
commissioner to relieve  royalty for fields that were  not yet in                                                               
production.  To  qualify,  the   field  had  to  be  sufficiently                                                               
delineated  to satisfy  the commissioner,  it had  to be  a field                                                               
that  would  not  otherwise be  economically  feasible,  and  the                                                               
royalty rate could not be reduced below five percent.                                                                           
MR. BANKS said the important  discussion that took place in those                                                               
days  was that  tinkering with  the royalty  modification statute                                                               
meant the legislature was tinkering  with contracts that had been                                                               
let  competitively.  In tinkering  with  the  statute, the  state                                                               
arguably was pushing  up against the doctrine  of material change                                                               
to  a  competitively  let  contract.  The  legislature  was  also                                                               
concerned  that the  royalty modification  be both  efficient and                                                               
effective. Effective means that  it actually changes the behavior                                                               
of  the  applicant,  and  they   go  into  production  when  they                                                               
otherwise would  not. Efficient  means the  state would  not give                                                               
away anymore royalty relief than was necessary.                                                                                 
4:50:56 PM                                                                                                                    
MR. BANKS  said the legislation  stipulated that  the information                                                               
provided to  the commissioner would  make a clear  and convincing                                                               
showing  that relief  was  in  the best  interest  of the  state.                                                               
Because of  the complexity of  the analysis, DNR has  the ability                                                               
to expedite the process by selecting  a contractor to do the work                                                               
and the lessee pays for it.                                                                                                     
He  explained that  DNR offers  a relief  mechanism on  a sliding                                                               
scale based on price, but there  is some latitude to tailor it to                                                               
the situation  at hand. In addition  to price, the relief  can be                                                               
conditioned  on  production  rates,  ultimate  recovery,  capital                                                               
expenditures or operating  expenditures. Finally, the legislature                                                               
can review the analysis through  the Legislative Budget and Audit                                                               
4:52:33 PM                                                                                                                    
MR. BANKS highlighted the following:                                                                                            
   · BP applied for royalty relief for Milne Point in 1995.                                                                     
   · UNOCAL in 1997 applied for royalty relief for ten platforms                                                                
     in  Cook   Inlet,  which  didn't   fit  any  of   the  three                                                               
     categories. The  legislature eventually amended  the statute                                                               
     to  allow a  decrease in  royalty from  platform production.                                                               
     Depending on the  rate of production, it could be  as low as                                                               
     five percent.                                                                                                              
   · Phillips in 1999 applied for royalty relief for the Tyonek                                                                 
     platform to  develop the Tyonek Deep  under the sufficiently                                                               
     delineated  new  field  category, but  the  application  was                                                               
     withdrawn when the company merged with Conoco.                                                                             
   · Pioneer in 2005 applied for and received royalty relief for                                                                
     the Oooguruk unit.                                                                                                         
   · E&I in 2007 applied for and received royalty relief for the                                                                
     Nakiachuk  unit. An  earlier application  by Kerr  McGee for                                                               
     that  same  unit  was  denied,  in  part  because  the  cost                                                               
     structure showed  that royalty relief wasn't  necessary. The                                                               
     E&I application had much better  information about the costs                                                               
     and  the  royalty relief  was  structured  around a  minimum                                                               
     price  protection,  rather  than an  outright  five  percent                                                               
     royalty relief. The Nakiachuk  sliding scale royalty doesn't                                                               
     kick in until the price falls below $42.64.                                                                                
   · Chevron applied for royalty relief at the Ivan River and                                                                   
     Stump  Lake units  in Cook  Inlet, but  the application  was                                                               
     withdrawn before a full analysis was done.                                                                                 
MR. BANKS mentioned  an earlier comment about the  huge amount of                                                               
royalty that  is collected  as part of  the state's  revenue, and                                                               
submitted that unless some of  that production is in the category                                                               
of "about to be shut in,"  there isn't a royalty relief mechanism                                                               
in statute that can have any effect on that production.                                                                         
SENATOR  STEDMAN  clarified  that  his  point  was  more  broadly                                                               
directed. He then asked if a  company could still ask for royalty                                                               
relief  given  the  opportunity  for  a  40  percent  exploratory                                                               
MR. BANKS  answered yes.  He explained that  DNR applied  the tax                                                               
credits under  ACES when evaluating the  Nakiachuk royalty relief                                                               
application, and ended up awarding  royalty relief, but Nakiachuk                                                               
was different than Oooguruk in  that the behavioral mechanism for                                                               
the Nakiachuk application  was to provide some  insurance for low                                                               
price situations.                                                                                                               
SENATOR  STEDMAN  asked  if  he   should  conclude  that  if  the                                                               
situation was  in front  of DNR  today and the  price of  oil was                                                               
$100/barrel,  royalty relief  would  not be  granted because  the                                                               
company's returns would be fairly attractive.                                                                                   
MR.  BANKS replied  they probably  wouldn't  qualify for  royalty                                                               
relief if costs and production rates  were the same, and the only                                                               
difference was the $100 price of oil.                                                                                           
4:59:30 PM                                                                                                                    
SENATOR WIELECHOWSKI asked about the  merit of having a provision                                                               
in law  to provide production tax  relief, much the same  as with                                                               
royalty  relief.  DNR  would  look  at  the  company's  books  to                                                               
evaluate  the economics  in terms  of meeting  hurdle rates,  net                                                               
present value and internal rates of return.                                                                                     
MR. BANKS  reiterated that royalty  relief is a  rather difficult                                                               
process simply  because of  the lengthy  analysis that  DNR does.                                                               
Second, he  said, the applicant has  to be sitting on  a prospect                                                               
that  is   sufficiently  delineated   to  provide  a   clear  and                                                               
convincing showing  that relief  is needed, and  it takes  a fair                                                               
amount of investment to get  to that point. Third, it's something                                                               
of a  deterrent in terms  of new exploration and  new activities,                                                               
in part  because nobody  is betting  on failure  and the  need to                                                               
request royalty relief. Finally, there  was the concern about how                                                               
different lessees  would be  treated under  the rules  of royalty                                                               
relief. The definition  of royalty relief was  tightly woven into                                                               
the  legislation so  there would  never  be a  situation where  a                                                               
commissioner could grant  relief to one applicant and  deny it to                                                               
another similarly situated applicant.                                                                                           
CO-CHAIR PASKVAN thanked Mr. Banks  and commented that production                                                               
tax reduction was an interesting  concept, and might be a process                                                               
that defines best  interests in a way that  gets positive results                                                               
for  both  the  state  and  the  company.  [SB  49  was  held  in                                                               
5:03:56 PM                                                                                                                    
There being  no further  business to  come before  the committee,                                                               
Co-Chair Paskvan adjourned the meeting at 5:03 p.m.