Legislature(2011 - 2012)BUTROVICH 205

02/16/2012 03:30 PM RESOURCES


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03:33:10 PM Start
03:33:51 PM SB192
03:37:12 PM Pfc Energy Presentation on Progressive Fiscal Structures
05:05:51 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+= SB 192 OIL AND GAS PRODUCTION TAX RATES TELECONFERENCED
Heard & Held
-Overview of Progressive Fiscal Structures
Presentation by PFC Energy
-- Testimony <Invitation Only> --
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                       February 16, 2012                                                                                        
                           3:33 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                                                                                                              
Senator Cathy Giessel                                                                                                           
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
SENATE BILL NO. 192                                                                                                             
"An Act relating to the oil and gas production tax; and                                                                         
providing for an effective date."                                                                                               
                                                                                                                                
     - HEARD & HELD                                                                                                             
                                                                                                                                
PFC ENERGY PRESENTATION ON PROGRESSIVE FISCAL STRUCTURES                                                                        
                                                                                                                                
     - HEARD                                                                                                                    
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: SB 192                                                                                                                  
SHORT TITLE: OIL AND GAS PRODUCTION TAX RATES                                                                                   
SPONSOR(s): RESOURCES                                                                                                           
                                                                                                                                
02/08/12       (S)       READ THE FIRST TIME - REFERRALS                                                                        
02/08/12       (S)       RES, FIN                                                                                               
02/10/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/10/12       (S)       Heard & Held                                                                                           
02/10/12       (S)       MINUTE(RES)                                                                                            
02/13/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/13/12       (S)       Heard & Held                                                                                           
02/13/12       (S)       MINUTE(RES)                                                                                            
02/14/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/14/12       (S)       Heard & Held                                                                                           
02/14/12       (S)       MINUTE(RES)                                                                                            
02/15/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/15/12       (S)       Heard & Held                                                                                           
02/15/12       (S)       MINUTE(RES)                                                                                            
02/16/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
JANAK MAYER, Manager                                                                                                            
Upstream and Gas                                                                                                                
PFC Energy                                                                                                                      
Washington, D.C.                                                                                                                
POSITION STATEMENT: Testified during the discussion of SB 192.                                                                
                                                                                                                                
TONY REINSCH, Senior Director                                                                                                   
Upstream and Gas Group                                                                                                          
PFC Energy                                                                                                                      
Washington, D.C.                                                                                                                
POSITION STATEMENT: Testified during the discussion of SB 192.                                                                
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
3:33:10 PM                                                                                                                  
CO-CHAIR  JOE  PASKVAN  called   the  Senate  Resources  Standing                                                             
Committee meeting  to order at 3:33  p.m. Present at the  call to                                                               
order were  Senators McGuire, French, Wielechowski,  Stevens, Co-                                                               
Chair Wagoner and Co-Chair Paskvan.                                                                                             
                                                                                                                                
            SB 192-OIL AND GAS PRODUCTION TAX RATES                                                                         
    PFC ENERGY PRESENTATION ON PROGRESSIVE FISCAL STRUCTURES                                                                
                                                                                                                              
3:33:51 PM                                                                                                                    
CO-CHAIR PASKVAN announced  that SB 192 was  before the committee                                                               
and that PFC Energy would  deliver a presentation [on progressive                                                               
fiscal structures.]                                                                                                             
                                                                                                                                
He related that  Alaska has many components to  its fiscal system                                                               
that  are  attractive  across  a  spectrum  of  oil  prices.  For                                                               
example, among the levers are  low royalties; 50 percent or lower                                                               
than the royalty in North  Dakota or Texas. Alaska has attractive                                                               
credits,   such  as   a  100   percent   deduction  for   capital                                                               
expenditures in the year spent,  plus 20 percent credit "on their                                                               
bottom  line."  It's  also  called  the  "comparative  front  end                                                               
loading  index." Alaska  also  disproportionately  shares in  the                                                               
geologic risk and is one of  the most attractive locations in the                                                               
world. Also  attractive to investors is  the royalty modification                                                               
component.                                                                                                                      
                                                                                                                                
He questioned how Alaska will  create a balanced fiscal regime in                                                               
order to  receive a fair  return on its generous  capital credits                                                               
to  investors in  the  North Slope  and  on its  disproportionate                                                               
geologic risk.                                                                                                                  
                                                                                                                                
^PFC Energy Presentation on Progressive Fiscal Structures                                                                       
3:37:12 PM                                                                                                                    
JANAK MAYER,  Manager, Upstream and  Gas, PFC  Energy, introduced                                                               
himself  as a  legislative  consultant hired  by the  Legislative                                                               
Budget  &  Audit Committee  to  analyze  Alaska's current  fiscal                                                               
structure and any  proposed changes to the structure.  One of the                                                               
requirements is  to build a  complex model of the  current fiscal                                                               
structure and of a wide  range of existing base production assets                                                               
with  the  potential for  new  production  from new  investments.                                                               
Another task is to provide presentations to the legislature.                                                                    
                                                                                                                                
He  related  that today's  presentation  will  cover three  broad                                                               
areas:  company  behaviors  and  investment  decision  making,  a                                                               
conceptual  overview  of  progressivity,  and  how  progressivity                                                               
works in other jurisdictions and under ACES.                                                                                    
                                                                                                                                
3:40:50 PM                                                                                                                    
TONY  REINSCH,  Senior  Director,  Upstream and  Gas  Group,  PFC                                                               
Energy,  said  that  his  focus is  on  strategy,  planning,  and                                                               
positioning of large international  and national oil companies in                                                               
the upstream sector of both oil and gas.                                                                                        
                                                                                                                                
He related that PFC has focused  traditionally on the area of the                                                               
oil  and  gas sector  that  has  been  the  weakest in  terms  of                                                               
company,  government,  and  regulator  analysis -  the  areas  of                                                               
above-ground risk. These are areas  such as competitor landscape,                                                               
or  who  owns  the  resources, political,  social,  and  economic                                                               
risks, and policy and regulatory  risks. He said that PFC advises                                                               
international  oil  companies  (IOC's),  national  oil  companies                                                               
(NOC's)  and  governments  on  how   these  risks  are  unfolding                                                               
globally.                                                                                                                       
                                                                                                                                
MR.  REINSCH began  by explaining  IOC decision  making regarding                                                               
capital allocation,  budget, and long-range planning.  He related                                                               
that he plans  to discuss company behaviors  and decision making,                                                               
especially  regarding  investment   decisions  and  decisions  on                                                               
whether to  develop particular resources  in the near term  or to                                                               
postpone development.  He said  he would  also cover  key metrics                                                               
including return  on capital employed  (ROCE), net  present value                                                               
(NPR),  and   internal  rate   of  return   (IRR),  as   well  as                                                               
consideration  of  asset  metrics versus  portfolio  metrics  and                                                               
differences between  integrated versus  non-integrated companies.                                                               
He  said he  would conclude  with  cash flow  allocation and  the                                                               
reallocation  of  free  cash flow  within  global  portfolios  as                                                               
projects and  basins move through  various stages  of development                                                               
to maturity.                                                                                                                    
                                                                                                                                
SENATOR STEDMAN joined the committee.                                                                                           
                                                                                                                                
3:44:38 PM                                                                                                                    
MR.  REINSCH  explained  that  oil and  gas  companies  follow  a                                                               
standardized process linking the annual  budget cycle to the long                                                               
range plan and corporate strategy.  They follow an annual process                                                               
that is  predictable. The  timing has to  do with  filing reports                                                               
and drilling seasons.                                                                                                           
                                                                                                                                
SENATOR  WIELECHOWSKI   asked  if  PFC  Energy   works  with  oil                                                               
companies and governments.                                                                                                      
                                                                                                                                
MR. REINSCH  replied that PFC  advises international oil  and gas                                                               
companies, governments, and national oil companies.                                                                             
                                                                                                                                
He continued  to explain  the capital  allocation cycle  within a                                                               
given  company.  The  first  quarter  of the  year  is  spent  on                                                               
strategy review and  updates about where the company  is going in                                                               
the longer  term. That process  carries through at  the corporate                                                               
level for much of the year.  The budget cycle begins in the third                                                               
quarter and  uses the  strategies and  long-range plan  to create                                                               
the capital expenditures of the coming budget.                                                                                  
                                                                                                                                
3:47:18 PM                                                                                                                    
MR. REINSCH explained  that slide 4 is an attempt  to capture how                                                               
companies  look at  the world  during the  planning and  strategy                                                               
process. The  process begins with a  view of the world  they will                                                               
be working in; economic markets,  energy supply, and geopolitical                                                               
considerations,  leading  to  a  view  on  oil  and  gas  prices.                                                               
Companies then look at the basins  in which they are operating or                                                               
may want to operate in  the future. Next, they identify blockers,                                                               
enablers,  gaps, and  logjams to  being able  to accomplish  what                                                               
they  want to,  and focus  on competitor  landscape and  markets.                                                               
From   that  analysis,   the  company   targets  objectives   and                                                               
identifies   objectives.   Finally,    the   company   identifies                                                               
strategies  and   uses  the  long-range  plan   to  make  capital                                                               
investments.                                                                                                                    
                                                                                                                                
He turned to  slide 6 to show corporate input  assumptions on the                                                               
external environment.  Companies have business units  that manage                                                               
operations  in specific  areas such  as the  Gulf of  Mexico, the                                                               
North  Sea in  the United  Kingdom, Alaska's  Prudhoe Bay,  Eagle                                                               
Ford Shale  Gas, and  Angola's deep  water production.  The units                                                               
are responsible  for developing  a long-range  plan, a  five year                                                               
plan, and a budget. He continued  to say "at corporate, those are                                                               
rolled  up," leading  to  a  discretionary and  non-discretionary                                                               
capital  budget available  for board  approval.  After the  board                                                               
approves  the  budget, capital  is  allocated,  the projects  are                                                               
approved, and the programs are executed.                                                                                        
                                                                                                                                
3:51:26 PM                                                                                                                    
MR. REINSCH moved  on to slide 8, which depicts  the issue of how                                                               
to  attract capital  for  a project  within  a corporate  budget.                                                               
There are a number of  considerations when determining whether an                                                               
oil  company  will   position,  or  continue  to   invest,  in  a                                                               
particular   asset,   basin,   or    country.   Some   of   these                                                               
considerations are  materiality, total capex exposure,  and full-                                                               
cycle economics/metrics.                                                                                                        
                                                                                                                                
He  continued  to say  that  each  project  is broken  down  into                                                               
discrete investment  decisions, in  the form of  Project Approval                                                               
Requests  (PAR's), creating  a natural  "state-gate" for  capital                                                               
approval and  allocation. Each stage-gate creates  an opportunity                                                               
for  the company  to continue,  amend,  suspend, or  exit/divest.                                                               
Each PAR has  an authorization for expenditure  (AFE) attached to                                                               
it. The sum of the AFE's in any given year is the budget.                                                                       
                                                                                                                                
3:54:22 PM                                                                                                                    
He related that slide 9  shows a program with multiple activities                                                               
over multiple  years. He noted  that discretionary  capital comes                                                               
up for discussion and approval every year.                                                                                      
                                                                                                                                
He  discussed  how companies  measure  the  performance of  their                                                               
investments  and  decide  to allocate  capital  to  one  activity                                                               
versus  another -  slide  10. Key  to  measuring performance  are                                                               
growth, profitability, efficiency, cash flow, and risk.                                                                         
                                                                                                                                
CO-CHAIR  PASKVAN asked  if, within  any one  company's decision-                                                               
making  process,  100 percent  of  the  project approval  request                                                               
would not be funded.                                                                                                            
                                                                                                                                
MR. REINSCH replied that with  $100 oil, many companies were able                                                               
to fund all of their  projects. Currently, not all activities are                                                               
funded.  Companies must  decide how  to balance  growth activity,                                                               
debt management, and returning capital to shareholders.                                                                         
                                                                                                                                
3:58:01 PM                                                                                                                    
MR. REINSCH  explained project selections and  decision metrics -                                                               
slide  11. Energy  companies employ  a variety  of benchmarks  or                                                               
metrics  to   rank  investment  opportunities  and   to  allocate                                                               
financial  capital.  Some of  the  more  common include:  pay-out                                                               
period,  internal  rate of  return,  net  present value,  recycle                                                               
ratio,  discounted  and  undiscounted  net  cash  flow  profiles,                                                               
maximum  negative cash  flow exposure,  net booked  reserves, and                                                               
capex/boe or cost per barrel of production capacity.                                                                            
                                                                                                                                
CO-CHAIR PASKVAN  inquired if there  was a selection  or decision                                                               
metric most often  used by a resource owner who  is attempting to                                                               
impose a production tax.                                                                                                        
                                                                                                                                
MR.  REINSCH said  the ranking  metric  is the  internal rate  of                                                               
return  (IRR)   because  it  provides  a   relative  ranking  and                                                               
allocation  across a  portfolio  of projects.  The  owner of  the                                                               
resource would be more interested  in the net present value (NPV)                                                               
as the ranking metric.                                                                                                          
                                                                                                                                
4:02:15 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if  information such  as the  rate of                                                               
return  or the  net present  value  is readily  available to  the                                                               
resource owners in the countries PFC Energy has worked in.                                                                      
                                                                                                                                
MR.  REINSCH  explained that  varies  by  country and  regulatory                                                               
structure. He  reported that  it was surprising  to find  that in                                                               
the  least  developed  jurisdictions,   in  terms  of  government                                                               
institutional capacity, the standard  for regulation and approval                                                               
is  increasingly  becoming  the  IRR,  which  the  companies  are                                                               
required to provide.                                                                                                            
                                                                                                                                
SENATOR WIELECHOWSKI  inquired about the standard  or average IRR                                                               
for which a project is deemed profitable or should go forward.                                                                  
                                                                                                                                
MR. REINSCH  answered that in  countries that are  just beginning                                                               
oil and gas  development, projects have IRR's of  greater than 25                                                               
percent. IRR's becomes less useful in more mature jurisdictions.                                                                
                                                                                                                                
MR.  MAYER added  that from  the government's  perspective, IRR's                                                               
happen most  in the less  developed countries that have  a strong                                                               
national oil company.                                                                                                           
                                                                                                                                
MR. REINSCH turned to slide 12  - net present value, which is the                                                               
estimated value of  a project when all future net  cash flows are                                                               
discounted  to the  present at  an appropriate  rate or  discount                                                               
factor. He  contrasted the advantages  and disadvantages  of NPV.                                                               
The main disadvantage is that it is difficult to rank projects.                                                                 
                                                                                                                                
He explained  slide 13 -  internal rate  of return, which  is the                                                               
discount rate  that equates all  future cash inflows  to outflows                                                               
at  a   point  in   time.  He   contrasted  the   advantages  and                                                               
disadvantages of IRR.                                                                                                           
                                                                                                                                
He  pointed  out  that  corporations  establish  a  "hurdle"  IRR                                                               
number. Projects with IRR's in  excess of the hurdle rate attract                                                               
budget capital, with  those below the hurdle rate  not funded. He                                                               
listed issues with IRR hurdle rates.                                                                                            
                                                                                                                                
4:12:51 PM                                                                                                                    
SENATOR  FRENCH  stated the  legislature  spends  a lot  of  time                                                               
guessing what  a company's IRR rate  is in order to  determine if                                                               
the   state's  investments   are   sufficiently  attractive.   He                                                               
requested  an example  of what  a good  IRR rate  would be  for a                                                               
major international oil company.                                                                                                
                                                                                                                                
MR. REINSCH  said it varies by  company. A good rate  would be an                                                               
IRR  threshold   at  15  percent   or  greater  for   a  domestic                                                               
investment, or 20 percent for an international investment.                                                                      
                                                                                                                                
He explained  the third  metric, the  return on  capital employed                                                               
(ROCE), as  described on slide  15. ROCE means net  profit before                                                               
interest and taxes, divided by  the gross capital employed, times                                                               
100.  The  ROCE  indicates  how  well  management  has  used  the                                                               
investment made  by owners  and creditors  into the  business. He                                                               
referred to two charts that  depicted ROCE, one of global players                                                               
and one of international players.                                                                                               
                                                                                                                                
He said  that seldom is  a company able  to perform at  high ROCE                                                               
and high growth;  they move in and out of  those cycles. Upstream                                                               
ROCE is  higher for  the larger  companies and  is lower  for the                                                               
intermediate companies because ROCE has a built-in capital bias.                                                                
                                                                                                                                
He  described  some of  the  issues  with ROCE.  Initially,  ROCE                                                               
penalizes an oil company for  major capital investments. Once the                                                               
projects  are  in place,  there  is  a  bias toward  large  asset                                                               
portfolios due to a material production cash flow.                                                                              
                                                                                                                                
4:17:57 PM                                                                                                                    
MR.  REINSCH   explained  why   fiscal  changes   impact  project                                                               
economics. It is  rare to find a company able  to perform at both                                                               
a  high efficiency  level, or  high ROCE,  and a  high production                                                               
growth level as measured by changes  in production. He used as an                                                               
example  the increase  in the  United Kingdom  supplementary ring                                                               
fence charge, where  the supplementary profits tax  of 20 percent                                                               
was increased  to 32  percent. The impact  was a  reallocation of                                                               
net cash flow  from the contractor to the  government with little                                                               
or no  impact on the development  of the basin or  the wells that                                                               
were drilled. The  result was the government gave up  a degree of                                                               
freedom in dealing with the price  cycle. When the price cycle is                                                               
down, it is harder to attract capital.                                                                                          
                                                                                                                                
SENATOR  FRENCH asked  how  the deductions  and  credits work  in                                                               
Alaska when calculating IRR's.                                                                                                  
                                                                                                                                
4:20:27 PM                                                                                                                    
MR. REINSCH explained that calculating  IRR's are part of company                                                               
operations that are almost impossible to assess externally.                                                                     
                                                                                                                                
SENATOR  FRENCH suggested  that $1  billion would  be the  figure                                                               
used to calculate IRR.                                                                                                          
                                                                                                                                
MR. REINSCH agreed.                                                                                                             
                                                                                                                                
MR. MAYER added that the  modeling work PFC Energy has undertaken                                                               
is aimed  at looking  at the entire  base of  existing production                                                               
for  producers  on  the  North   Slope,  as  well  as  trying  to                                                               
understand some  of the possible  new investments, because  it is                                                               
the  interaction of  all factors  that  determines the  economics                                                               
under  Alaska's system.  It is  important to  understand how  the                                                               
credits play into the equation.                                                                                                 
                                                                                                                                
SENATOR  FRENCH suggested  that the  figure of  $400 million  may                                                               
have to be used to calculate the IRR as well.                                                                                   
                                                                                                                                
MR. MAYER agreed  there would be an immediate tax  benefit on the                                                               
$1 billion.                                                                                                                     
                                                                                                                                
SENATOR WIELECHOWSKI  asked for  the date of  slide 17.  He noted                                                               
that oil  production has  increased in  the British  fields since                                                               
2011.                                                                                                                           
                                                                                                                                
MR. REINSCH reported that the  slide was introduced in the spring                                                               
or summer of 2011.                                                                                                              
                                                                                                                                
He  turned  to  the  issue  of  integration  on  slide  18.  Both                                                               
integrations  and  de-integration  are   hot  topics  ever  since                                                               
Marathon  and   ConocoPhillips  have  both   de-integrated  their                                                               
downstream  operations  from   their  upstream  operations.  Both                                                               
companies  maintain that  integration hides  value. De-integrated                                                               
entities are better capable  of developing appropriate strategies                                                               
and appropriate execution of those  strategies. He said there are                                                               
technical drivers  for integration; however, the  benefits can be                                                               
secured through contracts and partner  agreements. BP, TOTAL, and                                                               
Shell are  divesting from Africa  in favor of pure  play refiners                                                               
and marketers.                                                                                                                  
                                                                                                                                
CO-CHAIR   PASKVAN  asked   what   Mr.   Reinsch  thought   about                                                               
integration  of North  Slope crude  with  the West  Coast of  the                                                               
United States.                                                                                                                  
                                                                                                                                
MR. REINSCH  opined that the maturity  of the North Slope  and of                                                               
the refining  and marketing business  in North America  creates a                                                               
situation much like  the Canadian oil sands,  where the companies                                                               
can either integrate refineries  with the upstream operations, or                                                               
contract with  third parties. North  Slope crude would  fall into                                                               
that same category  with other crude flows.  Incentives to create                                                               
artificial barriers have eroded away.                                                                                           
                                                                                                                                
4:28:16 PM                                                                                                                    
He turned  to the issue  of basin  allocation and free  cash flow                                                               
distribution. He described  Alaska as a harvest area  and said he                                                               
would  discuss what  that means  regarding global  portfolios, as                                                               
shown on  slide 19.  PFC Energy  allocates company  activities to                                                               
particular basins on  the basis of whether those  basins are core                                                               
to the company, and whether their focus area is new venture.                                                                    
                                                                                                                                
He defined  harvest area  as an area  that produces  positive net                                                               
cash  flow,  with  investment  activity  typically  at  or  below                                                               
replacement level. Investing  is done to maintain  the cash flow.                                                               
There is  a limit to actual  or perceived growth. He  pointed out                                                               
that  the  oil  industry  has   largely  been  built  up  by  the                                                               
reallocation of free cash flow from one basin to another.                                                                       
                                                                                                                                
MR. REINSCH defined  the "sit and hold" category as  an area with                                                               
a substantial resource base, but  investment has been delayed due                                                               
to unattractive  fiscal terms or significant  above ground risks.                                                               
The company  may hold large projects  in this area but  hold back                                                               
the  pace  of  investment  until   the  risk  factors  have  been                                                               
addressed.  He used  the changes  taking place  in Libya,  Sudan,                                                               
Chad, and Venezuela as examples.                                                                                                
                                                                                                                                
4:31:11 PM                                                                                                                    
SENATOR FRENCH noted that Alaska  appears in the harvest area. He                                                               
wondered if  jurisdictions cycle in  and out of their  status and                                                               
how quickly that happens.                                                                                                       
                                                                                                                                
MR. REINSCH clarified  that the chart was not  PFC's analysis. He                                                               
said that companies do cycle  within base allocations in a couple                                                               
of ways.  Harvest assets for  one company  can be a  growth asset                                                               
for another company.  Apache is such a company  because they take                                                               
over  assets, such  as BP's,  and  use them  for growth.  Another                                                               
example is  the UK's North  Sea, which  has been in  harvest mode                                                               
for decades.  Chevron built the  majority of its  Asian portfolio                                                               
off of the free cash flow  generated from Europe and West Africa,                                                               
just as those jurisdictions had been  built by the free cash flow                                                               
generated from U.S. on-shore assets of Chevron.                                                                                 
                                                                                                                                
SENATOR FRENCH gave a hypothetical  example if the UK had decided                                                               
to  drop their  taxes  to entice  Chevron back  into  the UK,  it                                                               
wouldn't have worked. Chevron was  focused on a different part of                                                               
the world.                                                                                                                      
                                                                                                                                
MR. REINSCH agreed.                                                                                                             
                                                                                                                                
4:34:16 PM                                                                                                                    
CO-CHAIR  WAGONER  requested   more  information  about  Apache's                                                               
takeover of BP's assets.                                                                                                        
                                                                                                                                
MR. REINSCH  reported that  Apache first  stemmed the  decline of                                                               
the 40's Field  and then they grew the  production. The incumbent                                                               
company, BP,  had the capability to  do the same thing,  but they                                                               
had better prospects elsewhere.                                                                                                 
                                                                                                                                
CO-CHAIR PASKVAN  summarized that  BP turned  to another  area of                                                               
their diversified portfolio.                                                                                                    
                                                                                                                                
MR. REINSCH agreed. BP ended  up developing Deepwater in the Gulf                                                               
of Mexico.                                                                                                                      
                                                                                                                                
MR.  REISCH turned  to a  chart on  slide 20  that shows,  over a                                                               
three year  period from  2003 to  2005, the  sources and  uses of                                                               
cash flow on  a regional basis for the  largest international oil                                                               
companies. North  America and Europe  are the  largest generators                                                               
of  net  or  free  upstream  cash  flow.  Sub-Saharan  Africa  is                                                               
beginning to develop as a deep water player.                                                                                    
                                                                                                                                
He related that  the second chart shows sources and  uses of cash                                                               
flow between 2008 and 2010. It  shows Sub-Saharan Africa as a net                                                               
cash  flow generator  with the  capital going  to North  America.                                                               
There are substantial  shifts in how capital  is allocated across                                                               
portfolios on a global basis.                                                                                                   
                                                                                                                                
MR.  REINSCH described,  on slide  21, Nexen,  Inc. as  a company                                                               
that  initially built  its North  Sea assets  from the  cash flow                                                               
generated out  to Yemen,  and now  the cash  flow from  Europe is                                                               
being used to finance developments  in Canada. These moves can be                                                               
very rapid.                                                                                                                     
                                                                                                                                
He discussed  ExxonMobil's global  areas of  upstream operations,                                                               
as shown on slides 22 and 23.                                                                                                   
                                                                                                                                
4:38:08 PM                                                                                                                    
MR. MAYER  presented the principles  of fiscal regime  design. He                                                               
said he would address the  concept of progressivity with emphasis                                                               
on progressive  versus regressive  fiscal regimes,  the rationale                                                               
for   a   progressive  fiscal   regime,   how   the  concept   of                                                               
progressivity   works   in   a   range   of   other   hydrocarbon                                                               
jurisdictions,   and  the   problems  in   the  applications   of                                                               
progressivity.  He  shared  a favorite  quote  by  Jean  Baptiste                                                               
Colbert, the Minister of Finance  under King Louis XIV of France.                                                               
Colbert said,  "The art of  taxation consists in so  plucking the                                                               
goose as  to get the  most feathers  with the least  hissing." In                                                               
more  contemporary  terms,  that  art  of  taxation  consists  in                                                               
maximizing  revenues,  subject   to  two  important  constraints,                                                               
efficiency and competitiveness.                                                                                                 
                                                                                                                                
MR.  MAYER said  that efficiency  is  an absolute  concept -  the                                                               
degree of  distortion in a  taxation regime is something  "we can                                                               
assess  solely in  relation to  ourselves."  There is  a need  to                                                               
examine the incidence  of the tax under different  price and cost                                                               
levels  and  to  understand  what components  of  the  underlying                                                               
economic activity are being taxed.                                                                                              
                                                                                                                                
He  explained  that competitiveness  is  a  relative concept  and                                                               
requires  us  to  examine our  attractiveness  in  comparison  to                                                               
others. There  is a need  to understand what  other jurisdictions                                                               
we  are  competing  with  for capital  and  to  understand  whose                                                               
capital we are competing for, as  well as how rates of return for                                                               
projects  compare to  what our  target investors  can achieve  in                                                               
other jurisdiction.                                                                                                             
                                                                                                                                
He said the  goal is to find the  intersection between efficiency                                                               
and competitiveness, and  to find a regime that  does not distort                                                               
investment with rates that are internationally competitive.                                                                     
                                                                                                                                
4:44:58 PM                                                                                                                    
MR.  MAYER  showed  slide  31 which  depicts  the  efficiency  of                                                               
supply, demand, and price. The graph  on the right shows that the                                                               
supply  curve is  a  series  of various  projects,  such as  five                                                               
different classes  of oil regimes. The  point is that each  has a                                                               
very  different  cost  structure   and  very  different  economic                                                               
returns at a given oil price.                                                                                                   
                                                                                                                                
He used  slide 32 to explain  economic rent, the gap  between the                                                               
cost required to ensure a normal  return on capital and the price                                                               
received.                                                                                                                       
                                                                                                                                
He  related that  slide 33  depicts the  impact of  a 30  percent                                                               
royalty on  the five projects. The  royalty successfully captures                                                               
30 percent  of the  gross revenues  from projects 1  - 4  for the                                                               
government. The tax, however, is  highly distorting. Project 5 no                                                               
longer  earns  a   normal  return  on  capital;  if   it  were  a                                                               
prospective investment, it would now  have negative NPV and would                                                               
be  cancelled. If  the oil  price were  to fall,  the 30  percent                                                               
royalty would make further projects non-economic.                                                                               
                                                                                                                                
4:48:29 PM                                                                                                                    
MR.  MAYER defined  relative government  take as  government take                                                               
divided  by  divisible  income. Divisible  income  is  the  gross                                                               
revenues  less cost,  including capex  and transportation  costs.                                                               
Government take includes all payments  the government mandates in                                                               
its  function  as  a  sovereign:  royalties,  land  rental  fees,                                                               
property taxes,  production taxes,  and income  taxes. Government                                                               
take  does  not  include  amounts  the  government  earns  in  an                                                               
entrepreneurial function.                                                                                                       
                                                                                                                                
He  turned to  slide 35  to depict  the relative  government take                                                               
impact of  a 30  percent royalty.  The impact  of the  royalty is                                                               
very different  across different projects.  For project 5,  it is                                                               
100 percent,  but for project  1, it is  less than 30  percent. A                                                               
fixed  percentage royalty  is inefficient  and highly  regressive                                                               
with  regard to  costs  -  as costs  increase,  so does  relative                                                               
government  take.   Royalties,  however,   are  very   simple  to                                                               
administer.                                                                                                                     
                                                                                                                                
He  noted that  more  revenue  could be  created,  not by  taxing                                                               
production, but by the targeting of economic rent.                                                                              
                                                                                                                                
4:53:54 PM                                                                                                                    
Mr.  MAYER  turned  to  a brief  history  of  production  sharing                                                               
contracts, as  shown on slide  39. He said  that ACES is  in many                                                               
ways a reflection  of a recent trend seen  in tax/royalty regimes                                                               
around the world that have  endeavored to capture a greater share                                                               
of  rent, by  replication  many  aspects of  the  economics of  a                                                               
production sharing  contract (PSC). Until the  1960's and 1970's,                                                               
the  global  oil  industry  was  dominated  by  tax/royalty  type                                                               
concessions for  oil and gas  production. These were  very simple                                                               
to administer, and  made sense so long as  prices were reasonably                                                               
low and stable, and oil was easy to produce.                                                                                    
                                                                                                                                
He related  that, in  many cases,  relatively generous  terms for                                                               
oil  companies  reflected the  colonial-era  world  in which  the                                                               
concessions  had been  set. Rising  nationalism in  oil producing                                                               
countries saw  the first  moves away from  this system.  OPEC was                                                               
formed in 1960, and Indonesia  introduced the first "contracts of                                                               
work"  with  terminology  and mechanics  very  similar  to  later                                                               
PSC's.  The 1973  Arab oil  embargo sent  oil prices  from $3  to                                                               
$12/bbl, dramatically  eroding government take  under tax/royalty                                                               
systems,  as  international  oil  company  profits  surged.  This                                                               
resulted in the widespread rescission  of existing of concessions                                                               
in major oil producing nations and the introduction of PSC's.                                                                   
                                                                                                                                
4:57:39 PM                                                                                                                    
MR. MAYER  described the structure  of a  simple PSC -  slide 40.                                                               
Core to  the concept of  PSC is the differentiation  between cost                                                               
oil and  profit oil.  Cost oil  represents barrels  of production                                                               
required to  recover operating and  capital costs.  The remainder                                                               
of production is deemed profit oil.                                                                                             
                                                                                                                                
He related that the Malaysia-Thailand  joint development area has                                                               
one  of  the   simplest  PSC  structures  anywhere.   It  is  not                                                               
regressive  with  regard to  either  price  or cost.  Because  it                                                               
includes the  normal return  on capital  in the  tax base,  it is                                                               
regressive with regard to economic rent.                                                                                        
                                                                                                                                
He explained  that many PSC-type regimes  include progressive and                                                               
regressive  elements. Many  such  systems incorporate  regressive                                                               
elements  like  fixed-percentage   royalties.  Some  regimes  add                                                               
progressivity  to their  profit-focused components  to compensate                                                               
for regressive elements  of the regime to achieve  a more neutral                                                               
outcome.  Often  application  of  progressivity  has  been  taken                                                               
further,  to focus  on limiting  the  share of  rent received  by                                                               
IOC's  in   high  price  environments  and   maximizing  relative                                                               
government take.                                                                                                                
                                                                                                                                
He  said   that  tomorrow's  presentation  would   focus  on  how                                                               
progressivity works in  a number of different regimes  and how it                                                               
includes a  range of  different metrics. He  noted he  would also                                                               
focus on progressivity under ACES.                                                                                              
                                                                                                                                
CO-CHAIR  WAGONER  asked  whether the  presenters  could  explain                                                               
Alaska's total  tax system  to a  new producer  who was  ready to                                                               
invest in Alaska.                                                                                                               
                                                                                                                                
MR. MAYER stated  that Alaska has a very complex  tax system with                                                               
different impacts, depending on  the existing production base and                                                               
the nature  of a number  of factors.  He stressed that  a generic                                                               
modeling of  ACES wouldn't  tell the company  the reality  of the                                                               
field for a specific investment.                                                                                                
                                                                                                                                
5:05:51 PM                                                                                                                    
There being  no further  business to  come before  the committee,                                                               
Co-Chair   Paskvan  adjourned   the  Senate   Resources  Standing                                                               
Committee at 5:05 p.m.                                                                                                          
                                                                                                                                

Document Name Date/Time Subjects
PFC Energy_Bios2_Feb_2012.pdf SRES 2/16/2012 3:30:00 PM
SB 192
PFC Energy_Senate Resources_Slides_Feb_16_2012.pdf SRES 2/16/2012 3:30:00 PM
SB 192