Legislature(2011 - 2012)BUTROVICH 205

02/17/2012 03:30 PM RESOURCES


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Audio Topic
03:35:06 PM Start
03:36:51 PM SB192
03:38:00 PM Analysis of Oil Industry Investment Strategies Presentation by Pfc Energy
05:04:44 PM SB176
05:28:24 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
-Analysis of Oil Industry Investment Strategies
Presentation by PFC Energy
+ HB 144 REPORT ON FISHING STREAM ACCESS TELECONFERENCED
Scheduled But Not Heard
+= HB 185 EXEMPT DISCHARGES FROM USE OF MUNITIONS TELECONFERENCED
Scheduled But Not Heard
= SB 176 EXEMPTIONS FROM MINING TAX
Heard & Held
<Bill Hearing Continued from 2/15/12>
-- Testimony <Invitation Only> --
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                       February 17, 2012                                                                                        
                           3:35 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                                                                                                           
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Senator Gary Stevens - excused                                                                                                  
                                                                                                                                
OTHER LEGISLATORS PRESENT                                                                                                     
                                                                                                                                
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                                                                                                             
                                                                                                                                
ANALYSIS OF OIL INDUSTRY INVESTMENT STRATEGIES PRESENTATION BY                                                                  
PFC ENERGY                                                                                                                      
                                                                                                                                
     - HEARD                                                                                                                    
                                                                                                                                
SENATE BILL NO. 176                                                                                                             
"An Act exempting sand and gravel and marketable earth mining                                                                   
operations from the mining license tax; and providing for an                                                                    
effective date."                                                                                                                
                                                                                                                                
     - HEARD & HELD                                                                                                             
                                                                                                                                
CS FOR HOUSE BILL NO. 144(RES)                                                                                                  
"An Act requiring the Department of Natural Resources annually                                                                  
to deliver to the legislature and the governor a report on                                                                      
fishing stream access."                                                                                                         
                                                                                                                                
     - SCHEDULED BUT NOT HEARD                                                                                                  
                                                                                                                                
CS FOR HOUSE BILL NO. 185(RES)                                                                                                  
"An Act relating to an exemption from authorizations that may be                                                                
required by the Department of Environmental Conservation for the                                                                
firing or other use of munitions on active ranges."                                                                             
                                                                                                                                
     - SCHEDULED BUT NOT 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                                                                           
02/16/12       (S)       Heard & Held                                                                                           
02/16/12       (S)       MINUTE(RES)                                                                                            
02/17/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
                                                                                                                                
BILL: SB 176                                                                                                                  
SHORT TITLE: EXEMPTIONS FROM MINING TAX                                                                                         
SPONSOR(s): SENATOR(s) WAGONER                                                                                                  
                                                                                                                                
01/27/12       (S)       READ THE FIRST TIME - REFERRALS                                                                        
01/27/12       (S)       RES, FIN                                                                                               
02/15/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
02/15/12       (S)       <Bill Hearing to Continue 2/17/12>                                                                     
02/17/12       (S)       RES AT 3:30 PM BUTROVICH 205                                                                           
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
TONY REINSCH, Senior Director                                                                                                   
Upstream and Gas Group                                                                                                          
PFC Energy                                                                                                                      
POSITION STATEMENT: Accompanied Mr. Mayer in the analysis of oil                                                              
industry investment strategies.                                                                                                 
                                                                                                                                
JANAK MAYER, Manager                                                                                                            
Upstream and Gas                                                                                                                
PFC Energy                                                                                                                      
POSITION STATEMENT: Continued the presentation on oil industry                                                                
investment strategies.                                                                                                          
                                                                                                                                
MARGRET DOWLING, Staff                                                                                                          
Senator Tom Wagoner                                                                                                             
Alaska State Legislature                                                                                                        
Juneau, AK                                                                                                                      
POSITION STATEMENT: Explained CSSB 176 for the sponsor.                                                                       
                                                                                                                                
JOHANNA BALES, Deputy Director                                                                                                  
Tax Division                                                                                                                    
Department of Revenue (DOR)                                                                                                     
Juneau, AK                                                                                                                      
POSITION STATEMENT: Answered tax questions on CSSB 176.                                                                       
                                                                                                                                
TONY JOHANSEN, Partner                                                                                                          
Great Northwest, Inc.                                                                                                           
President, AGC of Alaska                                                                                                        
Fairbanks, AK                                                                                                                   
POSITION STATEMENT: Supported SB 176.                                                                                         
                                                                                                                                
MARK COTTINI, Professional Civil Engineer                                                                                       
Vice President, Alaska Rock Products Association,                                                                               
Mat-Su Borough, AK                                                                                                              
POSITION STATEMENT: Supported SB 176.                                                                                         
                                                                                                                                
BEN SIMMONS, Vice President and Controller                                                                                      
Anchorage Sand and Gravel (ASG)                                                                                                 
Anchorage, AK                                                                                                                   
POSITION STATEMENT: Supported SB 176.                                                                                         
                                                                                                                                
CHERYL SHAFER, Owner                                                                                                            
Dibble Creek Rock                                                                                                               
Kenai, AK                                                                                                                       
POSITION STATEMENT: Supported SB 176.                                                                                         
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
3:35:06 PM                                                                                                                    
CO-CHAIR  JOE  PASKVAN  called   the  Senate  Resources  Standing                                                             
Committee meeting  to order at 3:35  p.m. Present at the  call to                                                               
order were  Senators French, Stedman, Wielechowski,  McGuire, Co-                                                               
Chair Wagoner And Co-Chair Paskvan.                                                                                             
                                                                                                                                
            SB 192-OIL AND GAS PRODUCTION TAX RATES                                                                         
 ANALYSIS OF OIL INDUSTRY INVESTMENT STRATEGIES PRESENTATION BY                                                             
                           PFC ENERGY                                                                                       
                                                                                                                                
3:36:51 PM                                                                                                                    
CO-CHAIR PASKVAN  said the committee  would continue  the hearing                                                               
from  yesterday  on SB  192  and  the  analysis of  oil  industry                                                               
investment strategies by PFC Energy.                                                                                            
                                                                                                                                
^Analysis of  Oil Industry Investment Strategies  Presentation by                                                               
PFC Energy                                                                                                                      
3:38:00 PM                                                                                                                    
TONY  REINSCH,  Senior  Director,  Upstream and  Gas  Group,  PFC                                                               
Energy, introduced himself.                                                                                                     
                                                                                                                                
JANAK MAYER, Manager,  Upstream and Gas, PFC  Energy, and project                                                               
manager on fiscal terms reform  in Alaska for the LB&A committee,                                                               
said he  would pick up where  he left off yesterday.  He recapped                                                               
that he  talked about thresholds  and metrics that  determine how                                                               
and  where  companies  invest,  principals  for  a  well-designed                                                               
fiscal system,  what makes for efficient  or inefficient taxation                                                               
in  general   and  arrived   at  the   basic  question   of  what                                                               
progressivity is and how and why it is used.                                                                                    
                                                                                                                                
MR.   MAYER  said   he  would   continue   today  talking   about                                                               
progressivity  in  principal  and   look  at  some  international                                                               
comparisons, then  look specifically  at progressivity  under the                                                               
ACES regime and  answer some of the questions  on its limitations                                                               
to the  upside with  the oil  price; he would  then look  at what                                                               
overall levels of government take  looks like for ACES in several                                                               
scenarios  including what  would happen  if particular  caps were                                                               
placed on progressivity.                                                                                                        
                                                                                                                                
3:39:13 PM                                                                                                                    
Yesterday he started  with his favorite quote  from Jean Baptiste                                                               
Colbert about  how the art of  taxation is plucking the  goose so                                                               
as to  get the most feathers  with the least hissing.  In present                                                               
day  terms  that  means taxation  is  about  maximizing  revenues                                                               
subject   to  the   important  constraints   of  efficiency   and                                                               
competitiveness  -   efficiency  being   a  measurement   of  how                                                               
intelligently  we are  applying  a tax  and  whether it  distorts                                                               
investment opportunities  or only targets economic  rent, and the                                                               
idea that one could have a  very efficient tax and still not have                                                               
it necessarily be competitive.                                                                                                  
                                                                                                                                
3:40:34 PM                                                                                                                    
He  said that  royalties  are simple  to  administer, their  main                                                               
strength laying in the ease  of administration, but they are also                                                               
inefficient  precisely  because  at certain  prices,  some  costs                                                               
distort investments so  that by and large,  certain projects that                                                               
might otherwise go  forward will not go ahead.  Royalty is highly                                                               
regressive in  that as  costs fall  and prices  raise, government                                                               
take  decreases rather  than staying  neutral  or increasing.  He                                                               
said in principal, a well-designed  fiscal system, one that meets                                                               
Colbert's  test,  is  one  that   would  ideally  come  close  to                                                               
targeting  economic  rent  and taxes  things  that  don't  affect                                                               
economic  incentives, making  sure that  all projects  that might                                                               
otherwise be viable without the tax remain viable.                                                                              
                                                                                                                                
3:41:32 PM                                                                                                                    
MR.  MAYER said  as  a starting  point, one  of  the things  that                                                               
becomes  apparent  in thinking  about  things  this way  is  that                                                               
progressivity  (to achieve  the aim  of targeting  economic rent)                                                               
can be  used in many  ways. Internationally, it's  used primarily                                                               
not  to  create necessarily  an  overall  progressive regime  but                                                               
simply to  partially or completely counterbalance  the regressive                                                               
elements of one. A regime that  may for historical reasons have a                                                               
long-standing  fixed  percentage  royalty may  introduce  another                                                               
progressive  element  to offset  the  aggressive  effect of  that                                                               
royalty. PPT,  the precursor  to ACES, as  it was  first proposed                                                               
(as  opposed  to  as  it  was enacted),  looked  very  much  like                                                               
something that was  designed to create an  overall neutral regime                                                               
to counteract the regressive impact of the royalty.                                                                             
                                                                                                                                
In  other  cases, however,  progressivity  is  not used  just  to                                                               
counteract   the  regressive   effect  of   a  royalty,   but  to                                                               
deliberately  create  a progressive  regime,  one  that as  costs                                                               
increase, as oil prices increase,  as there is more economic rent                                                               
available,  to make  sure that  the  state's share  isn't just  a                                                               
neutral or a fixed percent, but takes more for the state.                                                                       
                                                                                                                                
3:43:55 PM                                                                                                                    
MR. MAYER  said that  both approaches  can yield  fiscal taxation                                                               
regimes  that are  entirely efficient  to the  extent that  it is                                                               
possible  to  distinguish  economic   rent  and  not  costs  from                                                               
ordinary  return  on  capital.  Regimes that  combine  both  high                                                               
levels of  government take and  high levels of  progressivity, if                                                               
well designed,  may meet that  first criteria of  efficiency, but                                                               
may not always meet the  second criteria of competitiveness. That                                                               
is something he would detail more.                                                                                              
                                                                                                                                
MR.  MAYER said  one of  his conclusions  was that  progressivity                                                               
works very  differently in different regimes.  In particular, one                                                               
can  design a  fiscal  regime  to use  a  wide  range of  metrics                                                               
against which to  be progressive. Using production  levels is the                                                               
simplest and  the most wide-spread application  of progressivity.                                                               
This  started   in  some  of  the   earliest  production  sharing                                                               
contracts  (PSC) that  sought to  increase  levels of  government                                                               
take on the  more profitable fields and it remains  a key feature                                                               
of production  sharing contracts in  many parts of the  world; it                                                               
is also used in creating variable royalty systems.                                                                              
                                                                                                                                
He explained  that Vietnam's fiscal terms  have two progressivity                                                               
elements with regard  to production amount; one is  a royalty and                                                               
one is the  profit oil split. Both vary depending  on how much is                                                               
produced  in a  given asset.  In essence,  he inserted,  the idea                                                               
that is  common to all  production bearing progressivity  is that                                                               
production  level  is used  as  a  proxy for  profitability,  but                                                               
production level is  a poor proxy for  profitability because it's                                                               
only one factor that will  determine profitability. If all of the                                                               
assets in  a given  country have a  very similar  cost structure,                                                               
then possibly a regime could be  tailored like this to come close                                                               
to  targeting  profitability,  but   that  approach  has  serious                                                               
limitations.  Vietnam has  a single  regime  for pre-2010  fields                                                               
that  increase  the  government  take  in  the  profit  split  as                                                               
production  goes up,  but after  2010 there  are three  different                                                               
possibilities. That reflects that the  vast majority of the asset                                                               
base previously  was fairly consistent shallow  water fields, and                                                               
the government of Vietnam understood that  if you want to go into                                                               
deep water,  those costs are  very different. Having  a structure                                                               
that  accommodates  those means  you  have  to think  differently                                                               
about how production  levels are taxed. That led in  this case to                                                               
increasing complexity in different options within the regime.                                                                   
                                                                                                                                
3:47:20 PM                                                                                                                    
He said  that these systems  are always bracketed. In  this case,                                                               
20,000 barrels  of production a day  is the first bracket  and up                                                               
to  50,000 barrels  a day  is another,  with the  royalty on  the                                                               
incremental barrels  increasing and  the profit  split decreasing                                                               
(but only on the additional barrels).                                                                                           
                                                                                                                                
3:49:07 PM                                                                                                                    
He said that Vietnam is just  one example of a production sharing                                                               
contract,  but   there  are  other  royalty-based   regimes  that                                                               
similarly  use a  price-based metric  for progressivity.  British                                                               
Columbia in  Canada is one  example of  a regime that  combines a                                                               
production-based  metric with  a price-based  metric  to try  and                                                               
achieve a slightly better measure of progressivity.                                                                             
                                                                                                                                
MR.  MAYER  said that  a  number  of other  regimes  specifically                                                               
target price  and only price  with regard to  progressivity. This                                                               
is  particularly  common in  windfall  profits  taxes around  the                                                               
world,  the idea  being  that  all of  the  given  assets in  the                                                               
country  will  economically  break  even below  a  certain  price                                                               
including  return  on capital  to  the  investor. So  above  that                                                               
threshold,  the government  would  like to  take some  increasing                                                               
amount of  the rents. For instance,  Venezuela's windfall profits                                                               
tax is  essentially a zero rate  at all prices below  $40, and 20                                                               
percent  for all  prices  between $40  and  $70. This  particular                                                               
aspect of  Venezuela's regime is  highly progressive, so  that 95                                                               
percent is taken  by the government at oil prices  over $100 (for                                                               
the incremental barrels).                                                                                                       
                                                                                                                                
SENATOR  FRENCH had  jumped ahead  to slide  16 that  showed that                                                               
Venezuela,  despite bracketing,  produces  a  government take  of                                                               
$100 a  barrel and remarked that  was virtually indistinguishable                                                               
from Alaska.  So, you  can get  to the  same place,  just through                                                               
different rates.                                                                                                                
                                                                                                                                
MR.  MAYER  agreed  that  was   entirely  correct.  The  lack  of                                                               
bracketing in ACES does one  thing: it makes a significantly more                                                               
progressive regime  than it  would otherwise  be and  the overall                                                               
effect is  that it  increases government take.  He said  he would                                                               
never suggest that  the lack of bracketing in ACES  makes, in and                                                               
of itself, an invalid or an undesirable characteristic.                                                                         
                                                                                                                                
3:51:51 PM                                                                                                                    
CO-CHAIR PASKVAN referred to slide 8  and asked if the 90 percent                                                               
threshold  for Venezuela's  windfall  profits  tax was  dependent                                                               
upon the price of oil staying at $95 for an entire year.                                                                        
                                                                                                                                
MR. MAYER replied  in the case of the $100  threshold, if the oil                                                               
price  is $110,  $10 of  that is  being taxed  at the  95 percent                                                               
rate, another  $10 is being taxed  at 90 percent and  another $20                                                               
is  being  taxed  at 80  percent  and  so  on.  That is  the  way                                                               
bracketing works in that system.                                                                                                
                                                                                                                                
SENATOR WIELECHOWSKI said the argument  they hear all the time is                                                               
that Alaska's  system takes  away the upside,  but a  system like                                                               
this one  takes away much more  of the upside. Yet  this is where                                                               
the majors have invested historically.  Why would they do that in                                                               
this situation but not in Alaska?                                                                                               
                                                                                                                                
MR. MAYER  replied that  Argentina is an  extreme example  of the                                                               
highest marginal  tax rate imaginable,  because it's  100 percent                                                               
after the  price hits $42,  but before that the  windfall profits                                                               
tax  component is  zero. He  explained that  the reason  a regime                                                               
like  that  is implemented  in  a  place  like Argentina  is  not                                                               
because  it's  a  particularly  efficient  or  sensible  form  of                                                               
taxation; it's because the high  levels of regulation distort all                                                               
sorts of aspects of the domestic energy market.                                                                                 
                                                                                                                                
3:54:29 PM                                                                                                                    
MR.  REINSCH  added that  Venezuela  was  a particularly  complex                                                               
example  and because  of the  impacts  of not  only the  windfall                                                               
profits  tax  but  other unilateral  conditions  imposed  by  the                                                               
government on  the contractors, virtually  all of the  majors and                                                               
large  companies left  Venezuela  and they  are  not going  back.                                                               
Chevron that  has stayed  deeply vested  in Venezuelan  heavy oil                                                               
sands is the  exception. This is a different  kind of development                                                               
- more like a manufacturing  process - much like integrated mined                                                               
oil sands  in Canada  where a  company doesn't  carry exploration                                                               
risk.  So a  company can  afford to  maintain operations  in this                                                               
kind of confiscatory fiscal environment.                                                                                        
                                                                                                                                
SENATOR  STEDMAN asked  what would  be the  marginal tax  rate in                                                               
this example if oil was $110.                                                                                                   
                                                                                                                                
MR. MAYER  replied the marginal  tax rate  in that case  would 95                                                               
percent.                                                                                                                        
                                                                                                                                
SENATOR STEDMAN  said if  all of the  western oil  companies were                                                               
out of Venezuela except for  Chevron, and if Chevron leaseholders                                                               
were put on the screen, "It would almost be I hate America."                                                                    
                                                                                                                                
3:56:54 PM                                                                                                                    
MR. REINSCH responded that Repsol,  Statoil and a number of other                                                               
companies are positioned in the  same type of asset, Repsol being                                                               
unique in  that it has  pursued very large scale  gas exploration                                                               
and  commercialization with  an  eye to  LNG, but  it  is also  a                                                               
Spanish speaking quasi or former  national oil company itself and                                                               
has  staked  a claim  as  a  linguistic  leader in  the  upstream                                                               
development in  South America  generally, and as  a result  has a                                                               
different sort  of incentive and strategy  towards the continent.                                                               
But there  is no question  that under  a different set  of fiscal                                                               
terms and  a different positioning  by the national  oil company,                                                               
that Venezuela would attract much  more foreign direct investment                                                               
than is the case today.                                                                                                         
                                                                                                                                
3:58:01 PM                                                                                                                    
MR. MAYER moved on to  slide 9 showing another more sophisticated                                                               
metric targeting economic rent a  little more directly by looking                                                               
at the process by which  projects recover their capital - instead                                                               
of  focusing on  just price,  just  production or  just cost,  to                                                               
assess projects on how far  they have recovered their capital and                                                               
taxing them  at a  progressively higher rate  as they  go further                                                               
above   simple   undiscounted   full  recovery.   For   instance,                                                               
Malaysia's 1997  and beyond (still  in place)  production sharing                                                               
contract was  introduced precisely  to be  more efficient  in the                                                               
sense  of  increasing  rates  of taxation  once  costs  had  been                                                               
recovered. It's based on a  metric called the "R-Factor." The "R"                                                               
stands  for  "ratio"  and  most   commonly  refers  to  comparing                                                               
cumulative  revenues  for a  project  to  cumulative costs  (both                                                               
operating and  capital). Having an  R-Factor of 1 means  that one                                                               
has  fully recovered  the pure  undiscounted accounting  costs of                                                               
the project.  As the R-Factor  increases, an R-Factor of  2 means                                                               
the basic  costs have been  doubled. So  the basic idea  behind a                                                               
regime  like Malaysia's  is that  at  an R-Factor  below 1  (well                                                               
before cost  recovery) there  is a relatively  high limit  on the                                                               
amount of revenues in any given  year that can count towards cost                                                               
recovery and  80 percent of the  split profit oil above  that can                                                               
be kept. As the R-Factor  rises above 1 and towards significantly                                                               
higher numbers,  that profit split  will go from 80  percent down                                                               
as  low as  30  percent.  It's quite  a  back-loaded regime  that                                                               
allows quick cost recovery for  the contractor and improves their                                                               
economics on  metrics like RR  and MPV,  but allows quite  a high                                                               
level of  government take by  taking progressively more  as costs                                                               
are recovered.                                                                                                                  
                                                                                                                                
SENATOR FRENCH  asked how the  Malaysian investment  level should                                                               
be compared to Alaska's.                                                                                                        
                                                                                                                                
4:01:44 PM                                                                                                                    
MR. REINSCH  answered that  the question  should be  how projects                                                               
are defined  and how capital  continues to be attracted  to them.                                                               
Malaysia  has   a  sharper  definition  of   "new  project."  For                                                               
instance,  a  field that  has  been  producing with  primary  and                                                               
perhaps  secondary water  flood techniques  and whose  production                                                               
has  matured and  it's time  to introduce  enhanced oil  recovery                                                               
would  be   presented  to  the   government  as  a   new  project                                                               
development  falling back,  now,  to  an R-Factor  of  1 for  the                                                               
incremental production.                                                                                                         
                                                                                                                                
SENATOR FRENCH asked if one  way to compare the investment levels                                                               
in Malaysia  versus those in Alaska  is to compare the  number of                                                               
barrels produced, the decline curve and the relative Capex.                                                                     
                                                                                                                                
MR. REINSCH  replied that  his expectation was  that on  a dollar                                                               
BOE  (barrel of  oil  equivalent)  basis he  would  see the  more                                                               
remote  nature  and  difficult operating  environment  in  Alaska                                                               
versus Malaysia.                                                                                                                
                                                                                                                                
SENATOR  FRENCH   asked  if  it   could  overcome   any  taxation                                                               
differences.                                                                                                                    
                                                                                                                                
MR. REINSCH replied that it may.                                                                                                
                                                                                                                                
SENATOR STEDMAN  said he  didn't see  how such  a model  could be                                                               
implemented with Alaska's aging field.                                                                                          
                                                                                                                                
MR. MAYER agreed  and said he wouldn't suggest  using an R-Factor                                                               
model  in Alaska,  because it  relies on  an accurate  historical                                                               
accounting for costs. In that  sense, it's something that is much                                                               
easier going forward than it is for existing mature assets.                                                                     
                                                                                                                                
4:05:11 PM                                                                                                                    
He  said that  slide 10  showed  another variation  of this  idea                                                               
focusing  with each  of  these steps  more  explicitly on  taxing                                                               
returns above  a baseline  normal return on  capital. One  of the                                                               
new ways some  regimes choose to do this is  to set progressivity                                                               
rates specifically based  on a particular IRR that  may have been                                                               
achieved.  For  instance,  in  the  shallow  water  Angola  where                                                               
significant above ground  risks exist the focus  is explicitly on                                                               
an IRR metric meaning that a  contractor's share of profit may be                                                               
quite high in any project that has  yet to make a 20 percent IRR,                                                               
(60 percent in the example). But  as IRR rises above those hurdle                                                               
rates, the  contractor's share gets progressively  less and less.                                                               
And  in  the case  of  Angola,  the  deep  water has  a  slightly                                                               
different regime than for the shallow.                                                                                          
                                                                                                                                
SENATOR  STEDMAN   said  when   the  legislature   initially  did                                                               
progressivity  in PPT,  they  contemplated doing  it  on the  IRR                                                               
basis,  but couldn't  get  that information.  He  asked how  this                                                               
would this be implemented on an aging field.                                                                                    
                                                                                                                                
MR. MAYER  answered that  it is  a system that  tends to  be seen                                                               
much more  in production  sharing contracts  than in  tax royalty                                                               
regimes. Part of  the reason for that is  that production sharing                                                               
contracts tend  more frequently  to exist  in places  that either                                                               
have  a  very  active  national  oil  company  that  is,  itself,                                                               
involved in the development of  the project or a highly developed                                                               
oil  ministry. Many  parts  of  the world  may  have very  little                                                               
government  capacity, but  have  a  highly functioning  petroleum                                                               
industry. Having  one of those things  helps you to do  this in a                                                               
way that if  you don't have that capacity it's  very difficult to                                                               
do.                                                                                                                             
                                                                                                                                
4:08:35 PM                                                                                                                    
MR. REINSCH  said the  actual application of  a system  like this                                                               
can  be  seen in  Tanzania  and  Mozambique, young  jurisdictions                                                               
where organizations  like the International  Finance Corporation,                                                               
World Bank and  International Monetary Fund (IMF)  were very much                                                               
involved  in supporting  development  of these  regimes. To  make                                                               
this operational, the companies were  required to give IRR models                                                               
to third party auditors to verify.                                                                                              
                                                                                                                                
MR. MAYER said  an extreme example of regimes of  this sort would                                                               
be  the   shift  in  certain   jurisdictions  away   from  simple                                                               
production  sharing   contracts  to  things  like   risk  service                                                               
contracts,   which  fundamentally   change   the   role  of   the                                                               
international oil  company from being  a risk bearing  partner to                                                               
being  a  system   where  government  takes  the   risk  and  the                                                               
international oil company is guaranteed  a particular IRR, but no                                                               
more. In  Malaysia the national oil  company has put a  number of                                                               
fields on a risk service contract basis.                                                                                        
                                                                                                                                
SENATOR STEDMAN asked  if he was aware of any  areas in the world                                                               
where industry  felt the  tax structure was  too heavy  and asked                                                               
the  government  to   look  at  IRR  methodology   to  bring  the                                                               
government split more in line with what they wanted to see.                                                                     
                                                                                                                                
MR. MAYER replied no.                                                                                                           
                                                                                                                                
4:12:10 PM                                                                                                                    
SENATOR MCGUIRE  asked for an  example of a government  bearing a                                                               
larger share  of the  risk, then  negotiating with  oil companies                                                               
for a  guaranteed rate of return  and nothing more. And  what did                                                               
he mean by the state bearing the risk in his Malaysia example?                                                                  
                                                                                                                                
MR. MAYER replied  that guaranteeing a 15 percent  rate of return                                                               
to work a field on one hand  limits the upside, but it also works                                                               
to guarantee an absolute maximum if  it turns out that the fields                                                               
is "dreadfully marginal."                                                                                                       
                                                                                                                                
SENATOR  MCGUIRE  asked  if  Malaysia  had  other  credits,  loan                                                               
incentives or guarantees.                                                                                                       
                                                                                                                                
MR.  MAYER replied  that  he  was not  aware  of  those sorts  of                                                               
things. He moved on to slide  11, an example of Australia that is                                                               
an  OECD jurisdiction.  It is  one that  in some  ways follows  a                                                               
method of  taxation that is most  similar to ACES in  that it's a                                                               
profit based taxation  regime, but it's one  that is particularly                                                               
thoughtful  and  clever. It's  the  only  system that  explicitly                                                               
targets just  economic rent rather than  profit, including return                                                               
on capital.  He thought  this was the  least distorting  and most                                                               
efficient  tax  regime in  the  world  -  whether  or not  it  is                                                               
competitive.                                                                                                                    
                                                                                                                                
4:15:39 PM                                                                                                                    
MR. MAYER said it's a very  simple regime compared to many. Other                                                               
than corporate  income tax,  it essentially  has one  single tax,                                                               
the petroleum  resource rent  tax, that is  levied at  one single                                                               
rate of 40 percent. That tax is  levied not on profit, but on the                                                               
cash flow of  the asset. The basic  idea of the system  is to try                                                               
to come  as close  as possible,  without establishing  a national                                                               
oil company and actually directly  participating in a project, to                                                               
replicate the economics of a  direct equity stake in the project.                                                               
Mr.  Mayer explained  that instead  of  directly contributing  40                                                               
percent  of  the capital,  those  costs  get recovered  from  the                                                               
government later  by being taken  out of the revenues  that would                                                               
otherwise go  in taxes  to it. Those  revenues are  inflated each                                                               
year by  a rate  that is  essentially equivalent  to the  cost of                                                               
capital for the  company; it's set in relation  to the government                                                               
bond rate plus  a certain percentage. By doing  so, the economics                                                               
on  a  net  present  value  basis are  identical  to  saying  the                                                               
government  puts in  40 percent  of the  costs and  takes out  40                                                               
percent of the benefits.                                                                                                        
                                                                                                                                
4:17:18 PM                                                                                                                    
Precisely because it's  a simple system, no royalty  and no other                                                               
taxes,  it's  one of  the  most  transparent and  rent  targeting                                                               
regimes he has seen anywhere.                                                                                                   
                                                                                                                                
MR. MAYER  said if government pays  100 percent of the  costs and                                                               
gets  100  percent  of  profits  and if  the  private  sector  is                                                               
actually doing all  the work, there is very  little incentive for                                                               
the  private  sector  to  minimize   the  costs  involved  in  an                                                               
undertaking.  This  is  important   in  talking  about  the  high                                                               
marginal  tax  rate  under  ACES,   because  in  principal,  high                                                               
marginal rates at times imply  the same thing. He elaborated that                                                               
if  a company  at any  point  under ACES  faces a  90 percent  or                                                               
higher  marginal  tax  rate,  that  doesn't  particularly  affect                                                               
project  economics or  the hurdle  rate;  but if  the company  is                                                               
considering installing  a new gas  processing facility  and could                                                               
spend $1 billion  to get a pretty good one  or spend $1.5 billion                                                               
to get  a really good one,  with a 95 percent  marginal tax rate,                                                               
the actual  incremental difference in  the spending on  those two                                                               
choices  is very  small and  it may  be worth  spending the  $1.5                                                               
billion, because  the full cost  of it will  not be borne  by the                                                               
company.                                                                                                                        
                                                                                                                                
SENATOR  STEDMAN said  that might  be getting  into the  issue of                                                               
gold plating.                                                                                                                   
                                                                                                                                
MR. MAYER agreed.                                                                                                               
                                                                                                                                
SENATOR STEDMAN asked when he thought  a system got close to gold                                                               
plating.                                                                                                                        
                                                                                                                                
MR. MAYER  responded that  he didn't  have a  particular marginal                                                               
rate  in  mind, but  certainly  marginal  rates  above 85  or  90                                                               
percent.                                                                                                                        
                                                                                                                                
4:21:36 PM                                                                                                                    
SENATOR STEDMAN said that previous  testimony had shown that with                                                               
Alaska's system the  state might be in a  negative position (over                                                               
100 percent) at prices over $200.                                                                                               
                                                                                                                                
MR. MAYER  said he had  looked at the  impact of ACES  under high                                                               
price environments  and only  at production  tax values  north of                                                               
$200 had he  seen rates over 100 percent. He  wanted to look into                                                               
that question further before answering definitively.                                                                            
                                                                                                                                
SENATOR STEDMAN agreed that they could  look at it in more detail                                                               
later.                                                                                                                          
                                                                                                                                
MR.  MAYER summarized  that one  could have  an efficient  regime                                                               
without distorting  project economics, but that  regime might not                                                               
be competitive on  the one hand and on the  other, one could have                                                               
a  competitive regime  in  terms  of low  government  take but  a                                                               
distorted  structure  meaning  that marginal  projects  would  be                                                               
unviable.  So the  principal that  one  would seek  to follow  is                                                               
having a  regime that is  neither inefficient nor  distorting and                                                               
without total government take so  high as to be uncompetitive. In                                                               
his  discussion  up  to  now,  he said  he  had  focused  on  the                                                               
efficiency   side  of   the   question  (progressivity)   looking                                                               
specifically   at  ACES,   at   ACES   with  some   international                                                               
comparisons, and ACES with certain modifications.                                                                               
                                                                                                                                
However, it's important to  understand that ultimately, effective                                                               
rates,  not  marginal rates,  are  the  ones that  drive  project                                                               
economics at  a given  price level. They  determine if  a project                                                               
meets a  hurdle rate for return  on capital or not.  But the fact                                                               
that  is the  case doesn't  mean that  marginal rates  are not  a                                                               
useful  piece of  information and  help in  understanding certain                                                               
key characteristics  of a  fiscal system. One  thing that  can be                                                               
understood  from  the  interaction   between  average  rates  and                                                               
marginal rates is  that it provides a useful  way of benchmarking                                                               
progressivity  of  different  regimes.  A graph  of  average  and                                                               
margin  rates just  for  production tax  components  of the  ACES                                                               
regime  shows the  high rate  of progressivity  for PTV  up until                                                               
$2.50 and the lower rate of PTV after that threshold.                                                                           
                                                                                                                                
MR. MAYER  explained that as  long as  the marginal rate  line is                                                               
above the  average rate  line, it is  a progressive  regime. When                                                               
the marginal  rate line is below  the average, it would  pull the                                                               
average rate down  as prices increased, and that  is a regressive                                                               
regime. By  subtracting the  average from  the marginal  rate one                                                               
can  create an  index that  can be  used to  understand just  how                                                               
progressive a regime is at a given price level.                                                                                 
                                                                                                                                
4:27:44 PM                                                                                                                    
CO-CHAIR  PASKVAN asked  him  to define  "gold  plating" and  the                                                               
context he  is using it  in and to explain  why he used  the term                                                               
"perverse incentives" when talking about high marginal rates.                                                                   
                                                                                                                                
MR. MAYER  replied that  the term "gold  plating" comes  from the                                                               
heart of his previous comments  about high marginal rates and the                                                               
incentives or lack  of lack incentives for  companies to exercise                                                               
cost  control   in  certain  circumstances.  In   this  sense  it                                                               
describes the sense  of his further description of  needing a new                                                               
facility and  spending $1 million for  one that would do  the job                                                               
or spending $1.5  billion to get an even better  facility but one                                                               
that doesn't in  and of itself justify the extra  half billion in                                                               
expenses. If  he faces  a 95  percent marginal  rate of  tax, his                                                               
incentive might be  to go for the $1.5  billion facility, because                                                               
after accounting for the effects  of his changed taxation rate in                                                               
addressing  that  investment he  would  only  be paying  a  small                                                               
portion of  that cost.  So if  there is  a very  small additional                                                               
benefit to him for making  that additional investment it might be                                                               
worth it since he is not the one paying the full cost of it.                                                                    
                                                                                                                                
CO-CHAIR PASKVAN  asked what  would be  the cumulative  effect of                                                               
combining the  concept of  gold plating  and high  marginal rates                                                               
with Alaska's capital credit.                                                                                                   
                                                                                                                                
MR.  MAYER  replied  it would  probably  move  toward  increasing                                                               
costs,  because   suddenly  it's  not  a   system  that  strongly                                                               
incentivizes cost control, but quite the opposite.                                                                              
                                                                                                                                
SENATOR WIELECHOWSKI  remarked that he understood  that it really                                                               
taxes the  cash flow. If  you look  at industry's $30  billion in                                                               
profits, it  would appear  that they are  taking the  profits and                                                               
they  are certainly  reinvesting. He  asked  if he  had seen  any                                                               
evidence of gold plating in Alaska's system.                                                                                    
                                                                                                                                
MR. MAYER  replied that  "gold plating" is  hard to  identify. If                                                               
one is  not the  individual actually making  purchasing decisions                                                               
and  deciding  whether one  needs  the  $1  billion or  the  $1.5                                                               
billion facility  it's very hard to  know whether it is  going on                                                               
or not. The  incentives might encourage it, but  he hadn't looked                                                               
at enough data to go further than that.                                                                                         
                                                                                                                                
SENATOR WIELECHOWSKI  said economists  used during ACES  talked a                                                               
lot about  the advantages of  a high  marginal tax rate,  and the                                                               
philosophy at the  time was that companies were  in harvest mode,                                                               
taking  the money  out  of  Alaska and  reinvesting  it in  other                                                               
places  around  the  world.  So, the  rationale  for  the  higher                                                               
marginal rate  was that it  would incent reinvestment  in Alaska,                                                               
and since  ACES has passed,  they have seen all-time  highs every                                                               
single year in  both capital and operating  investment. Are those                                                               
positive things  you would expect  to find about a  high marginal                                                               
tax rate?  Would you agree  with that philosophy  that encourages                                                               
reinvestment in the basin?                                                                                                      
                                                                                                                                
4:31:58 PM                                                                                                                    
MR. MAYER replied  that it is a very specific  set of carrots and                                                               
sticks and they  are set up to provide  significant benefits from                                                               
reinvesting. Whether those benefits  are sufficient to compensate                                                               
for  the  overall  high  level  of  government  take  is  another                                                               
question and he  didn't have a conclusive answer to  that at this                                                               
point.                                                                                                                          
                                                                                                                                
SENATOR  STEDMAN commented  that  it's more  complex than  saying                                                               
having  a  high  marginal rate  policy  encourages  reinvestment.                                                               
Alaska also  has up  front credits to  encourage capital  to stay                                                               
here  and if  they both  accelerate  at the  same time  all of  a                                                               
sudden there  are distortions  all over the  place and  the whole                                                               
thing  loses its  ability to  function at  more moderate  levels.                                                               
There  is the  issue of  the  theory and  then the  issue of  the                                                               
implementation, which  could be  explored in further  detail with                                                               
advanced modeling. He asked if they  could get a reference to the                                                               
price of oil on the chart of Production Tax Values, slide 13.                                                                   
                                                                                                                                
4:36:36 PM                                                                                                                    
MR.  MAYER responded  that slide  was showing  something specific                                                               
about  a specific  small portion  of the  ACES system;  there are                                                               
many different variables and cost is  one of the major ones; cost                                                               
over time  and how  cost is  phased over time  is another.  So if                                                               
they do this analysis on the  basis of oil price rather than PTV,                                                               
it's suddenly  no longer a  clear-cut simple graph. "It's  a much                                                               
fuzzier picture."                                                                                                               
                                                                                                                                
SENATOR STEDMAN said  maybe they could have a double  X axis with                                                               
current  prices underneath  so people  could  reference back  and                                                               
forth. Getting the concept across is kind of a two-edged sword.                                                                 
                                                                                                                                
MR. MAYER  said the basic  point he was making  about subtracting                                                               
the average  rate from the marginal  rate to get a  basic idea of                                                               
progressivity was  that this is  not the way other  fiscal system                                                               
comparisons are  made. This is  analysis PFC does  by identifying                                                               
assets in  their database of  assets as typical for  a particular                                                               
regime.  In some  cases they  may be  comparing a  relatively low                                                               
cost field  to a relatively  high cost field, but  that's because                                                               
both  of the  developments  are  typical of  that  area and  that                                                               
regime,  and they  are  trying to  get to  the  question of  what                                                               
government take  looks like given the  nature of the assets  in a                                                               
given jurisdiction in different places.  Here they do an exercise                                                               
of subtracting  the average  and marginal take  and see  that the                                                               
world is  split up  into progressive  and regressive  regimes, at                                                               
least at  the $100 price  level, with a  few neutral ones  in the                                                               
middle,  and  of those,  Alaska  is  among the  more  progressive                                                               
regimes around. In  doing the same exercise at  $140 barrel, that                                                               
becomes  even  more  the  case,  and  suddenly  it  is  the  most                                                               
progressive  regime  of  any in  the  Organization  for  Economic                                                               
Cooperation  and Development  (OECD) and  among the  highest they                                                               
have seen.                                                                                                                      
                                                                                                                                
4:39:48 PM                                                                                                                    
SENATOR STEDMAN,  referring to  the chart on  slide 14,  asked if                                                               
Texas, North  Dakota, the  Gulf of Mexico  and Louisiana  are all                                                               
regressive.                                                                                                                     
                                                                                                                                
MR. MAYER  replied yes  and said that  is precisely  because they                                                               
are  largely  royalty-dominated  regimes,  and  royalty-dominated                                                               
regimes are inherently regressive.                                                                                              
                                                                                                                                
SENATOR STEDMAN  commented like royalty  and property  and income                                                               
taxes.                                                                                                                          
                                                                                                                                
MR.  MAYER   said  of  those,   royalty  and  property   tax,  in                                                               
particular, are the most regressive components.                                                                                 
                                                                                                                                
SENATOR  STEDMAN recalled  that in  doing the  initial review  of                                                               
PPT,  the  system was  regressive  and  that's what  created  the                                                               
interest to insert a progressivity  measure to at least in theory                                                               
get them to the middle of the chart (slides 14).                                                                                
                                                                                                                                
MR. MAYER agreed and said in looking  at ACES at a range of price                                                               
levels, one of  the first things they will see  is an analysis of                                                               
PPT as it was originally proposed  rather than as it was enacted.                                                               
It's a very  neutral regime, because the  progressivity is almost                                                               
exactly enough to counter the regressive nature of the royalty.                                                                 
                                                                                                                                
4:41:39 PM                                                                                                                    
He  said  since they  were  addressing  the question  of  overall                                                               
competitiveness  of  a  regime,  regardless   of  whether  it  is                                                               
efficient  or  not,   it  was  useful  to  do   the  same  global                                                               
benchmarking model  exercise, and  again Alaska  ranks relatively                                                               
high in  the deck of  OECD countries;  at $100 barrel,  Norway is                                                               
the  highest, but  it is  the  second highest  OECD country.  The                                                               
regimes  above it  tend to  be  by and  large production  sharing                                                               
contract  regimes with  some  of the  high  levels of  government                                                               
take.  The analysis  at $114  barrels  makes that  even more  the                                                               
case; in this case, Alaska is about equal with Norway.                                                                          
                                                                                                                                
SENATOR WIELECHOWSKI asked in calculating  government take, if he                                                               
takes the actual  amount paid in a given year  and then backs out                                                               
what is  actually paid or  if he uses  the general tax  rates and                                                               
assumes that the full tax is being paid.                                                                                        
                                                                                                                                
MR. MAYER replied the basic methodology  is first of all to start                                                               
with the  concept of divisible  income being all of  the revenues                                                               
that  the project  creates  less its  costs  (per the  supplement                                                               
slide  yesterday).  That  divisible  income  can  be  distributed                                                               
either to  the private company  owning and operating  the project                                                               
or to  the government. If you  take away the after-tax  cash flow                                                               
based on  what the  model suggests that  goes to  the contractor,                                                               
everything  else,   in  some  form   or  another,  goes   to  the                                                               
government.   That's  the   absolute  government   take  (through                                                               
royalty, property taxes, profit sharing or other ways).                                                                         
                                                                                                                                
4:44:08 PM                                                                                                                    
SENATOR WIELECHOWSKI asked if he  was assuming in this government                                                               
take figure  the companies are  paying the full  corporate income                                                               
tax of 9.4 percent.                                                                                                             
                                                                                                                                
MR.  MAYER replied  that the  model, in  most cases,  uses a  9.4                                                               
percent tax rate, certainly in the Alaska model.                                                                                
                                                                                                                                
SENATOR WIELECHOWSKI said  he didn't think that  anyone in Alaska                                                               
pays 9.4 percent,  because for instance companies  are allowed to                                                               
write  off  their  losses  in other  regions.  He  thought  these                                                               
numbers were much lower for Alaska.                                                                                             
                                                                                                                                
MR. MAYER said that may be the  case here and in other regions as                                                               
well.  He would also say in  that sense, that state income tax is                                                               
one if the smallest components  of government take and would have                                                               
a small impact here.                                                                                                            
                                                                                                                                
4:45:23 PM                                                                                                                    
Slide 18 had  a few graphs of PPT as  proposed, that was designed                                                               
with enough progressivity to counteract  the regressive nature of                                                               
the royalty,  but that  led, relatively  speaking, to  an overall                                                               
neutral  regime that  is very  slightly  regressive, but  overall                                                               
almost spot-on  neutral using these  assumptions. It  indicated a                                                               
flat government take of 60 percent.                                                                                             
                                                                                                                                
4:47:01 PM                                                                                                                    
MR. MAYER  explained that slide 19  had graphs of PPT  as enacted                                                               
with  significantly greater  progressivity where  government take                                                               
rose from the flat 60 percent  level across all price levels to a                                                               
peak  of  about   74  percent,  given  the   assumptions  of  the                                                               
particular asset  type they were  looking at. As a  result, there                                                               
was  a decline  in  some of  the  MBV and  IRR  metrics for  this                                                               
generic representation of assets.  The primary difference between                                                               
ACES  as  it   was  proposed  versus  PPT  as   enacted  is  that                                                               
progressivity  kicks in  at  a lower  threshold  and that  raised                                                               
government take somewhat.  ACES as it was actually  enacted had a                                                               
significant  increase  in  the progressivity  and  a  significant                                                               
increase in the overall government take.                                                                                        
                                                                                                                                
CO-CHAIR PASKVAN  asked what  parameters as far  as costs  he was                                                               
imposing  and  what  increased  costs   would  do  to  the  total                                                               
government take column.                                                                                                         
                                                                                                                                
MR.  MAYER replied  that increased  costs  would suddenly  reduce                                                               
that figure.  This analysis had been  prepared on the basis  of a                                                               
lower-cost   development  on   the   Alaska   North  Slope,   not                                                               
inconsistent with the cost numbers  he had from the Department of                                                               
Revenue for  assets like  Prudhoe Bay,  but certainly  much lower                                                               
than he would anticipate for  some of the newer developments like                                                               
Oooguruk. He recalled using slightly  over $8 per barrel in Opex,                                                               
around  $5  barrel  in  pure maintenance  Capex  and  probably  a                                                               
similar amount in development Capex.  He said he could produce an                                                               
analysis like this based on a higher cost asset.                                                                                
                                                                                                                                
4:49:18 PM                                                                                                                    
SENATOR WIELECHOWSKI said  a $100 barrel of oil had  a 16 percent                                                               
royalty  and a  39 percent  production tax,  and he  thought more                                                               
accurate numbers would  be 12.5 percent for the  royalty and 27.5                                                               
to 28  percent for production  tax. He realized that  the federal                                                               
tax flexed with that, but wanted to know where he was wrong.                                                                    
                                                                                                                                
4:53:53 PM                                                                                                                    
MR. MAYER responded  that the percentages in his model  sum up to                                                               
a  total  government  take  of 60  percent,  half  from  royalty,                                                               
because  royalty is  12.5 percent  of the  gross revenues  of the                                                               
project, which  is more like  30 percent of the  divisible income                                                               
not 12.5 percent of  it.                                                                                                        
                                                                                                                                
SENATOR  FRENCH remarked  that the  Capex and  Opex numbers  were                                                               
significantly lower  than the ones  he recalled from  the Revenue                                                               
Sources Book and asked where they are from.                                                                                     
                                                                                                                                
MR.  MAYER replied  that they  come from  a number  of things.  A                                                               
different modeling  exercise would show different  cost fields in                                                               
the context of  different portfolios. The costs here  are not out                                                               
of keeping  with the  data he had  from the DOR  on costs  at the                                                               
lower end of the spectrum from places like Prudhoe Bay.                                                                         
                                                                                                                                
SENATOR FRENCH asked  if the commissioner or one  of his deputies                                                               
gave him these numbers.                                                                                                         
                                                                                                                                
MR. MAYER  answered that these  specific numbers, no; but  he did                                                               
have  numbers that  the department  was  able to  release in  the                                                               
cases where there were more  than three working interest partners                                                               
in an asset on general levels  of operating and capital costs. He                                                               
adjusted  his figures  to distinguish  between maintenance  costs                                                               
and capital going to incremental development.                                                                                   
                                                                                                                                
SENATOR FRENCH  said he  was looking forward  to seeing  maybe 20                                                               
more runs using  new fields, heavy oil fields  along with Prudhoe                                                               
Bay fields (for some standard to compare to).                                                                                   
                                                                                                                                
SENATOR  STEDMAN said  it would  be interesting  to look  at cost                                                               
numbers going  forward, because in  2013 the Revenue  Source Book                                                               
(that the  legislature has access  to) has about $13.60  a barrel                                                               
for Prudhoe Bay  Opex and about $17.50 for Capex  depending on if                                                               
you  are using  net or  gross on  royalty barrels.  It's quite  a                                                               
difference.                                                                                                                     
                                                                                                                                
MR. MAYER  agreed and said  from those aggregate numbers  one can                                                               
say  what an  average  fields looks  like, but  no  asset and  no                                                               
company  portfolio  looks like  an  average  field. This  was  an                                                               
exercise to  show the  lower-cost more  mature assets.  It's very                                                               
different than the higher cost ones.                                                                                            
                                                                                                                                
CO-CHAIR  PASKVAN said  that is  where some  of the  problems are                                                               
surfacing  from; they  are seeing  a  homogenized industry.  It's                                                               
well taken  that they  need to  understand more  specific fields'                                                               
operations within this overall fiscal system.                                                                                   
                                                                                                                                
MR. MAYER  said he hoped  the work they  are doing on  an ongoing                                                               
basis in  terms of coming  up with  a more detailed  and granular                                                               
model assist in that exercise.                                                                                                  
                                                                                                                                
4:54:47 PM                                                                                                                    
To address the question that was  asked about how ACES limits the                                                               
upside of  high oil prices for  an oil and gas  company, he said,                                                               
some of  that was  seen on  the preceding  slides looking  at the                                                               
escalating  level of  government across  prices. They  could also                                                               
maybe  graph net  present  value of  a project  over  a range  of                                                               
different prices  for some of  the different regimes.  They could                                                               
see  how  that  changes  over  time under  PPT  as  proposed,  as                                                               
enacted,  ACES  as proposed  and  ACES  as  enacted and  see  the                                                               
limitation of  upside. But whether capping  upside is necessarily                                                               
a  bad thing  in all  circumstance is  another question.  In many                                                               
ways it comes  to the heart of what they  have been talking about                                                               
in terms of taxing economic rent.                                                                                               
                                                                                                                                
MR. MAYER  said one  way one  could seek to  quantify this  is to                                                               
take  a  probabilistic approach  to  the  oil price  rather  than                                                               
simply saying they want to know  what the economics of this field                                                               
or  another  looks  like at  $60  or  $80  or  $100 a  barrel.  A                                                               
probability distribution curve  on slide 22 graphed  what each of                                                               
those looked under  different prices; the legend on  the right of                                                               
the  graph  showed  the  expected value  falling  as  the  upside                                                               
potential is curbed  by high progressivity. That  wasn't the same                                                               
as  saying  that by  curbing  the  benefit  of high  upside,  one                                                               
affects  the economics  that determine  meeting hurdles  rates or                                                               
some of the  other key metrics under which  capital is allocated,                                                               
but  it is  one way  of  understanding the  limitations on  price                                                               
upside that high progressivity creates.                                                                                         
                                                                                                                                
4:57:12 PM                                                                                                                    
MR. MAYER said finally to  answer the committee's question on the                                                               
impacts  of changing  nothing else  about the  ACES system  other                                                               
than the  level at which  progressivity is  capped that he  did a                                                               
graph on slide 25 capping progressivity  at 50, 60 and 70 percent                                                               
at any  price up to $230.  It shows almost no  difference; that's                                                               
because the 75  percent cap itself only binds  high prices around                                                               
the $220-230 mark  and a very slight decrease from  83 percent to                                                               
82 percent in the $230 case.                                                                                                    
                                                                                                                                
4:58:31 PM                                                                                                                    
CO-CHAIR  PASKVAN  asked  what  oil  price  the  75  percent  cap                                                               
translates to.                                                                                                                  
                                                                                                                                
MR. MAYER said  to get a precise  number he would have  to do the                                                               
math  again, but  somewhere in  the $300s.  He further  explained                                                               
that reducing the cap to 60  percent would show more of an impact                                                               
and capping  progressivity somewhere  around the $160  mark would                                                               
result in a neutral structure going forward.                                                                                    
Similarly,  looking at  this in  a probabilistic  approach (slide                                                               
22),  both straight  lines  come  up as  they  reach  the cap  on                                                               
production  tax   and,  again,  relatively   speaking,  increased                                                               
expected values on the higher oil side as a result.                                                                             
                                                                                                                                
4:59:56 PM                                                                                                                    
MR. MAYER  summarized that  there are  a wide  range of  forms of                                                               
progressivity in  different parts of  the world and a  wide range                                                               
of metrics on which it  can be based. Sometimes progressivity can                                                               
be used  to counterbalance the inherently  regressive elements of                                                               
a regime  - things  like a  royalty component  - and  other times                                                               
progressivity is applied in a  way that is deliberately taking as                                                               
large a share  of economic rent as possible. There  may be merits                                                               
in doing so,  but even if that can be  done efficiently, it could                                                               
affect competitiveness.                                                                                                         
                                                                                                                                
He said  that Alaska is  one of  the more progressive  regimes in                                                               
the world  and, based on  his assumptions, has a  relatively high                                                               
level of government  take. In the OECD, only Norway  has a higher                                                               
level and  at $140, oil is  about equal to Norway.  The higher GT                                                               
regimes tend to be PSE regimes  in some of the high-take parts of                                                               
the world.                                                                                                                      
                                                                                                                                
PPT as proposed was a  progressive component that counterbalanced                                                               
other  regressive elements  to create  a  fairly neutral  regime.                                                               
Progressively, as  time has gone  on, the regime has  become more                                                               
and more  progressive, more focused  on capturing  higher amounts                                                               
of economic  rent at higher  prices and  less focus on  simply at                                                               
creating a neutral regime.                                                                                                      
                                                                                                                                
5:02:24 PM                                                                                                                    
CO-CHAIR  PASKVAN  thanked Mr.  Mayer  and  Mr. Reinsch  for  the                                                               
presentation  over  the  last  two   days  and  held  SB  192  in                                                               
committee.                                                                                                                      
                                                                                                                                
At ease from 5:02 p.m. 5:04 p.m.                                                                                                
                                                                                                                                
               SB 176-EXEMPTIONS FROM MINING TAX                                                                            
                                                                                                                                
5:04:44 PM                                                                                                                    
CO-CHAIR WAGONER  announced consideration of SB  176 [version 27-                                                               
LS1201\M was before the committee].                                                                                             
                                                                                                                                
CO-CHAIR PASKVAN moved  to bring CSSB 176( ),  version \B, before                                                               
the committee for purposes of discussion.                                                                                       
                                                                                                                                
CO-CHAIR WAGONER objected for discussion purposes.                                                                              
                                                                                                                                
MARGRET DOWLING, staff to Senator  Wagoner, explained that the CS                                                               
to  SB  176,  removes  standing gravel  operations,  quarry  rock                                                               
operations and  marketable earth  from the mining  licensing tax.                                                               
This is because  it is extremely cumbersome to  both industry and                                                               
the state.  For example,  in the  last five  years an  average of                                                               
about $268,000  was collected as  a result of the  mining license                                                               
tax,  and it  cost the  Department of  Revenue about  $150,000 to                                                               
collect it. In  addition, in FY2011 when the  182 operations were                                                               
subject  to  the   tax,  that  included  both   sand  and  gravel                                                               
operations and  quarry rock operations. Of  those 182 operations,                                                               
only 17  were actually required  to pay the tax,  largely because                                                               
many  of   them  were  small   operations  serving   their  local                                                               
communities  that  fell  within  the $40,000  exemption  for  net                                                               
taxable income.                                                                                                                 
                                                                                                                                
5:07:30 PM                                                                                                                    
MS.  DOWLING  said  it's  cumbersome  to  tax  these  businesses,                                                               
because  they  produce  many  products   -  different  grades  of                                                               
aggregate, sand, concrete, concrete blocks,  pit run and the like                                                               
-  and in  order to  comply with  this tax,  all of  the expenses                                                               
associated with  each product have  to be tracked.  Sometimes one                                                               
expense can be  attributed to a number of  different products and                                                               
their  task, then,  is  to try  to determine  which  part of  the                                                               
expense  is attributable  to  which product  and  to allocate  it                                                               
appropriately.                                                                                                                  
                                                                                                                                
It  gets  fairly complex  and  involves  quite  a bit  of  record                                                               
keeping.  A letter  in their  packets  from Secon  said it  takes                                                               
about 200 hours per year to  do the recording keeping required to                                                               
file a  tax return and  respond to  audit requests. If  a company                                                               
owns  more than  one pit,  it  has to  file  a tax  return and  a                                                               
schedule for each  pit. Even if an operation is  so small that it                                                               
qualifies for  the $40,000  net income  exemption, it  still must                                                               
file a  tax return and  keep records. That  is why the  burden of                                                               
this  tax is  pretty  extraordinary relative  to  the actual  tax                                                               
revenue that is generated.                                                                                                      
                                                                                                                                
5:09:27 PM                                                                                                                    
MS. DOWLING  pointed out that  60 to  80 percent of  the material                                                               
that comes  out of the  ground in  Alaska goes into  public works                                                               
projects  that serve  state residents  in local  communities. So,                                                               
what really  happens is  that the  state ends  up paying  on both                                                               
sides of the equation; they pay to  collect the tax and then as a                                                               
consumer it  ends up paying  for the  tax again. In  addition, it                                                               
pays  for the  overhead portion  for the  bookkeeping that  these                                                               
companies have to add to the price of their materials.                                                                          
                                                                                                                                
5:10:28 PM                                                                                                                    
MS.  DOWLING  explained  that the  reason  marketable  earth  was                                                               
included in this  measure was to address a  Department of Revenue                                                               
and  industry concern  that once  they took  out sand  and gravel                                                               
that someday  some regulator or  some member of the  public would                                                               
see marketable earth  and wonder if it included  sand and gravel.                                                               
She  understood  that  there  are  no  tax  returns  filed  under                                                               
marketable earth now, so it wouldn't cause any harm.                                                                            
                                                                                                                                
In addition,  she said, the  reason quarry rock was  excluded was                                                               
because there  are just too few  of them. In the  last five years                                                               
only  four to  six companies  have filed  tax returns  under that                                                               
designation. So  keeping quarry  rock in  would not  be achieving                                                               
the   efficiencies  they   are  trying   to  achieve   with  this                                                               
legislation.                                                                                                                    
                                                                                                                                
5:11:40 PM                                                                                                                    
SENATOR WIELECHOWSKI said they had heard  a lot over the last few                                                               
years about  rare earth minerals  and he wanted to  be absolutely                                                               
certain that taking  out marketable earth was  not removing those                                                               
sorts of things.                                                                                                                
                                                                                                                                
5:12:23 PM                                                                                                                    
JOHANNA  BALES,  Deputy  Director, Tax  Division,  Department  of                                                               
Revenue (DOR),  said her understanding  is that  marketable earth                                                               
includes things  such as peat,  top soil  and clay. She  said the                                                               
Department of Law looked at  the rare earth elements to determine                                                               
whether or  not that  would cause  a problem,  but to  be honest,                                                               
they  weren't sure  those  types of  elements  were even  covered                                                               
under the mining license tax.                                                                                                   
                                                                                                                                
Another  good point  to consider  was that  rare earth  elements,                                                               
unlike  the marketable  earth, such  as  peat and  top soil,  are                                                               
locatable minerals,  and excluding the marketable  earth wouldn't                                                               
affect  them,   but  this   issue  should   lead  to   a  further                                                               
conversation and  some research in  the future if the  rare earth                                                               
elements start being produced.                                                                                                  
                                                                                                                                
5:13:33 PM                                                                                                                    
SENATOR WIELECHOWSKI  said he thought the  conversation needed to                                                               
happen  now  if  they  are contemplating  removing  it  from  the                                                               
state's tax structure. Taxes are hard  to change down the line if                                                               
someone  discovered  and started  to  mine  rare earth  minerals,                                                               
which are  extremely valuable. He  said he supported  the concept                                                               
of exempting sand, quarry rock and  gravel, but he didn't want to                                                               
go  far  beyond  that.  He   strongly  preferred  clarifying  the                                                               
definition.                                                                                                                     
                                                                                                                                
5:14:32 PM                                                                                                                    
MS.  BALES  responded   that  that  was  a   valid  concern.  The                                                               
definition of  mining in statue includes  "valuable metals, ores,                                                               
minerals,"  and  that  she would  immediately  consult  with  the                                                               
Department of  Law on  whether or not  rare earth  elements would                                                               
fit under that language.                                                                                                        
                                                                                                                                
5:15:11 PM                                                                                                                    
CO-CHAIR  WAGONER  asked her  to  do  that  and said  they  would                                                               
probably hold this bill until next Tuesday.                                                                                     
                                                                                                                                
SENATOR FRENCH concurred  with that and asked  why the department                                                               
spends $150,000 each fiscal year  examining and auditing sand and                                                               
gravel tax returns (on page 2 of the fiscal note).                                                                              
                                                                                                                                
MS. BALES explained  that that amount has been  expended over the                                                               
last  five years.  Back in  2006, the  Matanuska Susitna  Borough                                                               
contacted  them  about several  sand  and  gravel operators  that                                                               
could not get  permits from the borough because  they didn't have                                                               
the  state's  mining  license.  At  that  point,  the  department                                                               
realized that a  significant number of sand  and gravel operators                                                               
were actually  not in  compliance. So, they  spent the  last five                                                               
years  bringing several  hundred sand  and gravel  operators into                                                               
compliance.  The same  page of  the fiscal  note indicates  there                                                               
were only 11  licensees at the time, and in  2011 there were 189.                                                               
So,  about 170  taxpayers were  brought into  compliance and  the                                                               
resulting tax was  negligible. Until they did  that exercise they                                                               
had no idea that most of  the operators were small and because of                                                               
the $40,000  exemption, didn't pay  tax. She said  the department                                                               
had already  started moving  resources back  to other  excise tax                                                               
programs after diverting them to help with this.                                                                                
                                                                                                                                
5:17:42 PM                                                                                                                    
CO-CHAIR WAGONER opened the public hearing.                                                                                     
                                                                                                                                
5:17:57 PM                                                                                                                    
TONY  JOHANSEN, partner,  Great Northwest,  Inc., Fairbanks,  and                                                               
president, AGC  of Alaska, supported  SB 176. He said  early last                                                               
year  his company  received  a two-page  audit  request from  the                                                               
Department  of Revenue  concerning their  sand and  gravel sales.                                                               
The  request listed  19  detailed sets  of  information and  data                                                               
needed to  perform an  audit of  the mining  license tax  for the                                                               
years  2008 and  2009,  paperwork that  would  take their  office                                                               
manager weeks to assemble. In  frustration, he said, he contacted                                                               
John MacKinnon, the executive director  of the AGC of Alaska, and                                                               
after researching the  issue last summer, the  AGC approached the                                                               
DOR about  the problems and  with suggestions on how  the present                                                               
requirements could  be improved.  After researching  the revenues                                                               
generated and  the cost of  their collection,  the administration                                                               
recommended that  the simplest  and best  solution was  to exempt                                                               
quarry  rock  and sand  and  gravel  operations from  the  mining                                                               
license  tax  requirements. Everyone  recognized  it  as a  "true                                                               
nuisance tax."                                                                                                                  
                                                                                                                                
5:20:15 PM                                                                                                                    
MARK  COTTINI, Professional  Civil Engineer  and Vice  President,                                                               
Alaska Rock  Products Association,  Mat-Su, said he  supported SB                                                               
176. He said he represented 10  gravel pits in the Mat-Su Borough                                                               
and  that  he  is  also  vice president  of  a  gravel  screening                                                               
business and owns  a pit that receives gravel  royalties from the                                                               
company that operates  it. He had never paid mining  taxes to the                                                               
state of Alaska, he said, and  all of the small gravel pit owners                                                               
and the small gravel pit  screening business think the mining tax                                                               
is  broken and  concurred with  the earlier  presenter that  they                                                               
should be exempted from the mining licensing tax.                                                                               
                                                                                                                                
5:22:06 PM                                                                                                                    
BEN SIMMONS,  Vice President and  Controller, Anchorage  Sand and                                                               
Gravel (ASG),  Anchorage, said he  has extensive  experience with                                                               
the mining  license tax and  supported SB 176. He  concurred with                                                               
prior  testimony  that  the  statute  is  very  ambiguous  as  it                                                               
pertains to sand  and gravel. For the most part  the other metals                                                               
and minerals  that are covered  by the statute are  gold, silver,                                                               
zinc, lead and so forth,  but Anchorage Sand and Gravel currently                                                               
produces and stocks 20 to 40  products made with sand and gravel.                                                               
Complying  with the  current  audit  requirements of  determining                                                               
fair  market value  for  each product  is  very cumbersome,  time                                                               
consuming and requires a lot data and a lot of paper.                                                                           
                                                                                                                                
He  said the  tax is  inconsistent as  it's applied  to sand  and                                                               
gravel producers, because each producer  is different. A supplier                                                               
like Anchorage Sand and Gravel  sells approximately 70 percent of                                                               
its  production to  third parties  and  uses 30  percent for  its                                                               
internal operations  compared to  a general contractor,  who, for                                                               
instance, sells approximately 30 percent  of his product to third                                                               
parties  and uses  70 percent  internally for  large construction                                                               
jobs.  The average  sales prices  calculation for  each of  those                                                               
exact same  products is  different from  one supplier  to another                                                               
and from producers.                                                                                                             
                                                                                                                                
MR. SIMMONS  said it just took  him more than 18  months and cost                                                               
more than  $50,000 to complete  an audit  for tax years  2005 and                                                               
2006, and the amount of  taxes collected were negligible compared                                                               
to what the state had to do to get them.                                                                                        
                                                                                                                                
5:25:21 PM                                                                                                                    
CO-CHAIR WAGONER thanked him and went to Cheryl Shafer.                                                                         
                                                                                                                                
5:25:30 PM                                                                                                                    
CHERYL  SHAFER,  owner,  Dibble   Creek  Rock,  Kenai,  said  she                                                               
supported  SB 176.  She said  her family  runs a  small sand  and                                                               
gravel and ready  mix business on the Lower  Kenai Peninsula. She                                                               
reiterated what everyone  had been saying that the  mining tax is                                                               
burdensome. Because they own a number  of pits, she has to file a                                                               
double mining tax  for each piece of property  simply because the                                                               
property  is in  their family  name  and she  is currently  being                                                               
audited by  the DOR  for three  years of  past mining  taxes. She                                                               
only  has  a two-person  office  and  has spent  weeks  supplying                                                               
information and answering questions.  It is difficult to separate                                                               
out   the  mining   activities  from   the  family's   integrated                                                               
activities. More  time is  actually spent  with trying  to comply                                                               
with filing a correct mining tax  return than for her filling out                                                               
her corporate tax return.                                                                                                       
                                                                                                                                
5:27:36 PM                                                                                                                    
CO-CHAIR WAGONER  added that  this is  an opportunity  that every                                                               
politician looks forward to -  taking something off the books not                                                               
putting something  on the  books. He  found no  further testimony                                                               
and closed the public hearing.                                                                                                  
                                                                                                                                
He  said  SB  176  would   be  held  in  committee  awaiting  the                                                               
information on rare earth minerals.                                                                                             
                                                                                                                                
5:28:24 PM                                                                                                                    
CO-CHAIR WAGONER, seeing no further business, adjourned the                                                                     
Senate Resources Standing Committee meeting at 5:28 p.m.                                                                        

Document Name Date/Time Subjects
PFC Energy_Bios_Feb_2012.pdf SRES 2/17/2012 3:30:00 PM
SB 192
23 - SB 176 Support Testimony ARPA 021512.pdf SRES 2/17/2012 3:30:00 PM
SB 176
1 CSHB144 Sponsor Statement.pdf SRES 2/17/2012 3:30:00 PM
HB 144
2 CSHB144 ver I.pdf SRES 2/17/2012 3:30:00 PM
HB 144
3 CSHB144(RES) Sectional Analysis.pdf SRES 2/17/2012 3:30:00 PM
HB 144
4 CSHB144(RES) Summary of Changes.pdf SRES 2/17/2012 3:30:00 PM
HB 144
5 CSHB144-Fiscal Note-HB144-DNR-LATD-02-23-11.pdf SRES 2/17/2012 3:30:00 PM
HB 144
6 CSHB144 Fiscal Note-HB144-DFG-SFD-02-17-11.pdf SRES 2/17/2012 3:30:00 PM
HB 144
7 HB144-DNR-MLW-12-13-2011.pdf SRES 2/17/2012 3:30:00 PM
HB 144
8 HB 144 Support Docs Combined.pdf SRES 2/17/2012 3:30:00 PM
HB 144
1 CSHB185res Sponsor Statement.pdf SRES 2/17/2012 3:30:00 PM
HB 185
2 HB0185A.PDF SRES 2/17/2012 3:30:00 PM
HB 185
3 HB0185B.PDF SRES 2/17/2012 3:30:00 PM
HB 185
4 HB185-DEC-WQ-03-11-11.pdf SRES 2/17/2012 3:30:00 PM
HB 185
5 HB185-DEC-WQ-12-03-11.pdf SRES 2/17/2012 3:30:00 PM
HB 185
6 DEC Response to (H) RES HB 185- Munitions Ltr.PDF SRES 2/17/2012 3:30:00 PM
HB 185
7 AK_CWA_Support_Letter_Mar_2011.pdf SRES 2/17/2012 3:30:00 PM
HB 185
8 DMVA Letter to Support CWA Amendment.pdf SRES 2/17/2012 3:30:00 PM
HB 185
9 FEDERAL WATER POLLUTION CONTROL ACT Summary.pdf SRES 2/17/2012 3:30:00 PM
HB 185
PFC Energy_Alaska_Senate Resources_Slides_Feb_17_2012.pdf SRES 2/17/2012 3:30:00 PM
SB 192