Legislature(2017 - 2018)BUTROVICH 205
01/24/2018 03:30 PM Senate RESOURCES
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| Overview: Alaska's Oil & Gas Royalty, Unitization Process | |
| Adjourn |
* first hearing in first committee of referral
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ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
January 24, 2018
3:30 p.m.
MEMBERS PRESENT
Senator Cathy Giessel, Chair
Senator John Coghill, Vice Chair
Senator Natasha von Imhof
Senator Kevin Meyer
Senator Bill Wielechowski
Senator Click Bishop
MEMBERS ABSENT
Senator Bert Stedman
COMMITTEE CALENDAR
OVERVIEW: ALASKA'S OIL & GAS ROYALTY, UNITIZATION PROCESS
- HEARD
PREVIOUS COMMITTEE ACTION
No previous action to record
WITNESS REGISTER
ED KING, Special Assistant to the Commissioner
Department of Natural Resources (DNR)
Juneau, Alaska
POSITION STATEMENT: Provided overview of Alaska's oil and & gas
royalty, unitization process.
ACTION NARRATIVE
3:30:10 PM
CHAIR CATHY GIESSEL called the Senate Resources Standing
Committee meeting to order at 3:30 p.m. Present at the call to
order were Senators Coghill, Bishop, Wielechowski, Meyer, and
Chair Giessel. Senator Stedman was excused.
^Overview: Alaska's Oil & Gas Royalty, Unitization Process
Overview: Alaska's Oil & Gas Royalty, Unitization Process
3:30:38 PM
CHAIR GIESSEL announced the only order of business today was the
oil and gas royalty and unitization process overview. She said
Alaska was one of the nation's largest producers of crude at one
point in its history. The State of Alaska has a unique
subsurface mineral resource and as the land owner is receiving
royalty for that. The Department of Natural Resources (DNR) is
entrusted to extract the maximum value from those resources for
the people of Alaska and it does that through a system of lease
sales, royalty contracts, and by authorizing plans of
development. Today they would hear more about that from the
department.
3:31:44 PM
ED KING, Special Assistant to the Commissioner, Department of
Natural Resources (DNR), Juneau, Alaska, made the disclaimer
that this is an educational presentation and not necessarily
instructive. He didn't want to imply that this committee doesn't
know any of these things he is talking about here, but he wants
to make sure the public is up to speed on some of the topics
that get glossed over in other contexts.
3:32:58 PM
MR. KING said he would be talking about oil and gas contracts,
leases and royalties, and how the Division of Oil and Gas (DOG)
manages the state's mineral resources that it owns under the
lands that were conveyed to it at statehood. The DNR manages
those minerals by leasing rights to an oil and gas developer to
extract those resources, bring them to market, and generate
revenue from them. This is not uncommon; it happens all over the
world, not only in oil and gas, but in any other business that
has these kinds of contractual relationships between business
entities.
He described the types of oil and gas contracts:
-Service contract: A contract that an oil owner would enter into
with an oil and gas producer, like one would contract with a
builder to build a house. In these cases, the resource owner
maintains ownership of the resource and takes on all the risk.
The contractor usually gets paid back through the sale of the
oil, anyway, so there isn't necessarily a cash outlay, but the
risk is born by the owner of the resource and is not shifted to
the developer. This is the least common of the types of
contracts, but he has heard they are becoming more popular. They
can be found in places like Iraq where when one hears that Iraq
has a 99 percent government take, it is because they are only
paying a major international oil company to produce its oil. The
company isn't bearing any of the risk.
3:35:17 PM
SENATOR VON IMHOF joined the committee.
-Production sharing agreement/contract: Outside of the U.S. in
the modern era, this is the most common type of agreement where
the owner of the resource partners with an international oil
company. It is very common in Eastern Europe and South America.
Typically, the international oil company will front the capital
and then recover it through the recovery of the resource.
-Concession agreement: In the U.S. and Canada where private
individuals actually have mineral rights, this is the most
common type of agreement. This is where one concedes one's
rights to the royalty or the resource to another party for a
period of time. Then they would be responsible for bringing the
resource to production and take the risk of the costs and
capital. They have ownership of the resources while it's under
contract. These agreements can be structured to look very
similar to production sharing agreements (PSA), but the main
difference is in how the owner of the resource is defined and
who bears the risks, and ultimately who gains the rewards.
MR. KING said this broad spectrum of contracts provides ways a
government and oil company can interact with one another but
comparing these contracts to one another can be misleading as
the terms are very difficult to compare.
3:38:30 PM
MR. KING said Alaska is unique, being the sovereign owner of the
resource, whereas in the Lower 48, private individuals are the
owners. Alaska is also governed by a constitution that is
largely developed around this private mineral interest.
He briefed the committee that when Alaska became a state, and
even pre-statehood in the 1920s when the U.S. military was
converting from coal to oil, it became really important to
protect its ability to provide the protection that it needed to.
So, the Mineral Leasing Act of 1920 was enacted it separate the
oil and gas from other minerals and required federal lands to be
managed through the leasing of those oil and gas resources.
After WWII, a concern arose that if the U.S. used up all its oil
and gas it wouldn't be able to maintain its defense program and
governments around the world started looking at other sources
for oil and gas. Lots of exploration activities went on through
Europe, China, Russia, Northern Africa and the Middle East. This
Mineral Leasing Act is still what is governing all the activity
that is happening in Alaska. So, through the 1950s and as Alaska
entered statehood in 1959, the federal government leased oil and
gas rights in the Cook Inlet, specifically and the pre-statehood
leasing structure was used as a template for how the state would
progress after getting to statehood and writing a constitution.
Under the Mineral Leasing Act, a decision was made that revenues
generated on federal leases would be divided: 50 percent to the
state that owned the resource, 10 percent to the federal
government, and the other 37.5-40 percent to the Reclamation
Fund, a fund that was created in the early 1900s to generate
infrastructure projects, like dams and irrigation to settle the
western states.
When the Alaska Statehood Act was passed, the ability for Alaska
to draw off that fund didn't exist. So, Alaska was given that 40
percent. When people talk about the 90 percent to Alaska on
federal lands and 10 percent to the federal government, that is
the evolution of events that lead to that outcome. All revenues
that are generated on federal lands under federal lease go to
the federal government and 90 percent gets returned to the state
to be used for whatever the state deems appropriate.
3:43:34 PM
In 1959, Governor Egan questioned whether it was worth it to use
the state's land selection for oil and gas lands since 90
percent of the revenues were coming to the state anyway. When
Governor Hickel became the governor in 1966, he made the
decision to select a lot of those lands on the North Slope. The
federal lease sale model was used, and the state received $900
million ($5 billion in today's dollars) in its first lease sale.
MR. KING said that there are places in the National Petroleum
Reserve - Alaska (NPR-A) where that 90/10 split doesn't apply
and then it is a 50/50 split. The 1002 Alaska National Wildlife
Refuge (ANWR) provision that just passed in a continuing
resolution (CR) in Congress replaced the 90 percent provision
with a 50 percent provision and the 50 percent going to the
state is dedicated to the NPR-A Impact Fund. Article 8, Section
12, of the Alaska Constitution laid out in the Mineral Leasing
Act provision where the state was mandated to lease its oil and
gas resources, and that first sale was following that provision.
The Alaska Land Act was subsequently passed by the Alaska
Legislature under AS 38.05.180, the state statute that guides
all DNR's processes. It demands that the state use leasing for
managing its oil and gas resources.
When the energy crisis happened in the 1970s, there was an oil
embargo and prices spiked up. Those were the conditions that
allowed the Trans-Alaska Pipeline System (TAPS) to be built. It
happened again in 1977 as construction was just being completed.
With the issues around land claims just prior to that, the state
didn't have any lease sales between 1974 and 1980. So, the when
Permanent Fund provision talks about the pre-1980 leases and the
post-1980 leases, this is what it is referring to. And this is
why the state is using leasing and not some other form of
contract to manage its oil and gas resources.
3:47:30 PM
MR. KING said it's important to remember that a lease is a
contract (slide 4) between the state and another party. When
signing a contract, the legislature through the Alaska Lands Act
gave DNR the authority to enter into these contracts. So, when
DNR holds a lease sale and issues these leases, the state is
entering into a contract with a producer to take possession of
the oil in return for a portion of the production and many other
things within the lease agreement. Importantly, it is a contract
and therefore governed by contract law; it can't just be amended
or changed because one party wants to.
However, the Legislature gave DNR the authority to change a
contract in very specific instances. One is when a lease joins a
unit. DNR also has the authority under .180(j) to reduce royalty
rates in specific instances. Those are the only instances in
which DNR has the authority to renegotiate a contract. Any other
renegotiations must happen with the legislature's approval and
neither DNR nor the lessee can do anything on their own.
3:49:20 PM
MR. KING said a lease has several important provisions (slide
5). This exclusive right for access to the resource is done for
a set period of time, historically 10 years. Recently, that was
reduced to seven years with an opportunity to extend for another
three if a company is diligently progressing towards production.
The lease terms provide three important revenue terms; one is a
royalty, which is a reservation of part of the state's interest
in the resources. When the resources are produced, the lease
allows a company to sell those resources for their own benefit,
but whatever the royalty rate is that is reserved for the state.
The minimum royalty allowed is 12.5 percent or one-eighth. When
the barrels are produced and brought to market, the state has
the right to that one-eighth of that production.
There is also a rental payment for each of the 10 years, even if
oil isn't produced. This ensures that the state is getting some
revenues from the contracts the state enters.
The third revenue term is a "bonus bid," which is an upfront
payment that a company will provide to the state for the right
to enter into a contract.
3:51:56 PM
Lease interests can be transferred or reassigned with department
approval. Whatever the primary term is that is how long a
company has to get the lease into production. If they get into
production, they are allowed to maintain that lease as long as
they are producing.
3:52:48 PM
Leases are issued annually on an areawide basis (slide 6). Only
lands owned by the state are leased, about 105 million acres.
All other acres are federal or Native Corporation lands, and a
few homesteads (owned prior to statehood). The Bureau of Land
Management (BLM) leases federal lands.
SENATOR BISHOP asked him to clarify what he just said about
private lands.
MR. KING said that the Alaska Native Claims Settlement Act
(ANCSA) gave 40 million acres to the Native corporations and
those are considered private lands. A very small sub-set of
people were land owners in Alaska before statehood and they do,
in fact, own the mineral rights. Those are also private lands.
However, when he says, "private lands," he is typically talking
about Native corporation lands.
SENATOR BISHOP said he believes some production is coming off
some of those lands.
MR. KING said yes, in Cook Inlet.
3:55:21 PM
He said the federal waters around the state are managed by the
Bureau of Ocean and Energy Management (BOEM) that conducts its
own lease sales. Those are not within the state's borders, but
the production can flow through the state borders, so the state
is still interested in those lease sales in the Chukchi and
Beaufort Seas and Cook Inlet. BLM and BOEM are both subdivisions
of the Department of Interior.
State land leases are carried out by DNR, specifically through
the Division of Oil and Gas (DOG) leasing section, which
prepares and evaluates lease sales, and issues the leases. They
get support from the Resource Evaluation and Commercial sections
within the DOG. These people have a high degree of education in
either geology, geophysics, petroleum engineering, economics,
finance, and things like that. They make sure that the bid terms
in the lease sale are generating the maximum benefit for the
state.
3:57:01 PM
MR. KING said the department doesn't always just lease lands.
There are areas where the resource potential is less known and
in those situations, they can issue an exploration license. Then
a company can go out and have exclusive rights to explore for
resources in that area. If a company has success, that license
can be converted into a lease.
3:57:52 PM
He said leasing in Alaska has evolved a lot since the first
sales in the late 60s. Now the department just provides an
areawide lease sale every December. An area might be the whole
North Slope or the Beaufort Sea (slide 7). Effectively, this
means that all the state lands included in the sale are
available for bid. A big production is made out of opening all
the bids in the Dena'ina Center in December and reading them
aloud. The department makes sure the bidders are qualified and
the highest bidder is awarded the lease.
AS 38.05.180 also authorizes special lease sales for tracts of
land with different bid terms. It could be a six-year primary
term and drilling a well within the first three years, for
example. Currently, the department is evaluating whether it
wants to hold a special lease sale next summer.
3:59:46 PM
SENATOR VON IMHOF asked if he is allowed to indicate what the
special lease sale might be.
MR. KING replied that broadly the department received some
seismic tax credit data that has just been made public, and some
of the lands under that data are unleased lands. So, they
thought they would pull those lands out from the areawide and
conduct a special lease sale to see if there is additional
interest given the additional information. It's on the North
Slope.
4:00:32 PM
CHAIR GIESSEL asked if DNR is charging a fee for access to the
seismic information that is being released now.
MR. KING answered yes; a regulation change implemented a fee and
the department has collected $140,000 with another $100,000
coming soon. The DNR anticipates $300,000 I receipts this year
from the seismic data sales.
4:01:08 PM
MR. KING proceeded to discuss royalties and bonus bids saying it
is very difficult to evaluate competing bids on a tract of land,
because of multiple terms that can be altered. So, instead,
everything is held constant except for one term, and the bidders
can bid that one term. The division can choose which term to
bid; it can be the royalty rate, the bonus bid or some other
term. This is what "bid variable" refers to. In modern times,
the bonus bid is almost always the bid variable.
4:02:37 PM
SENATOR WIELECHOWSKI asked what the average price is per acre.
MR. KING replied that it depends on the lease and how much is
known about the potential in the area. Leases in North Dakota in
2003, for instance, would only get $25/acre, but as soon as the
shale revolution started and the resource became known, there
was a lot of competition around getting into those leases and it
drove the bid variables up to thousands of dollars. In Alaska,
something similar happened: in the early lease sale there was a
lot of uncertainty around the potential. After the first
Prudhoe Bay State Well No. 1 was drilled in 1968 and success was
had, the next lease sale brought in $900 million worth of bids.
Generally speaking, the value of the resource increases with
proximity to infrastructure and what is known about a formation
structure. If not much is known and it is a ways from
infrastructure, the bid is usually minimum.
SENATOR WIELECHOWSKI asked how much that is.
MR. KING answered $25/acre.
SENATOR WIELECHOWSKI said he just wanted to know an average for
Alaska leases versus North Dakota or Texas.
MR. KING said he didn't have that figure off the top of his
head, but he would get it.
CHAIR GIESSEL asked if Mental Health Trust (MHT) lands are
managed through DNR and if they have the same terms.
MR. KING replied that the trust is managed through the
Department of Revenue (DOR). The trust received a land
allotment, which is managed by the Trust Land Office, and that
is housed within DNR, but it conducts its own land disposals.
DNR provides the trust's procurement and support.
SENATOR BISHOP said he thought DGF funds were provided to fund a
position in DNR.
MR. KING said balancing the bonus bid versus the royalty rate is
a delicate matter, because the royalty is only paid if one gets
to production. So, the higher royalty rate only makes sense if
one actually gets to production. When a company is deciding on
how much it wants to pay for a lease, it takes into account what
it knows about the resource and what potential economic gain it
can get from it. The higher the royalty rate is the less value
the lease has and the lower the bonus bid is.
SENATOR BISHOP commented that the companies are making a mini-
RIK/RIV decision inside the bonus bid.
MR. KING agreed that the company makes the decision on how much
it is willing to pay for the lease.
4:08:21 PM
He explained that prior to 1980, all leases were for a fixed-
rate and under a DL-1 lease. Leases are contracts and endure as
long as one has production. So, even though they had only a 10-
year primary term, about 300 leases that were issued before 1980
are still producing oil today.
During the 1980s, a lot of countries started to move towards
production sharing agreements; the federal law and Alaska's
Constitution still ruled here. The federal government
experimented with new ways to issue lease terms and one of them
was a "net profit share lease (NPSL)," which turns into
something very similar to a production sharing agreement, even
though the construct and specific legal situation is different.
The state had one lease sale where the NPSL was the bid
variable. Twenty-four of the NPSLs are still active today.
Another way the federal government and the state were both
experimenting with lease terms was through a sliding scale where
the royalty rate would change based on some factor: the rate of
production or the price of oil, for instance. Today, all North
Slope leases are issued at a fixed one-sixth rate and
competitors are allowed to compete using the bonus bid as the
variable.
4:12:03 PM
SENATOR WIELECHOWSKI asked what percent of produced oil pays the
higher one-sixth royalty.
MR. KING answered about 70 percent of the oil is still from the
DL-1 leases that were issued in the 60s and early 70s with a
12.5 royalty rate.
SENATOR WIELECHOWSKI recalled SB 21 (passed in 2013) had
provision that said companies that paid this 16.67 percent
royalty actually paid lower production taxes. Is that correct?
4:13:03 PM
MR. KING answered yes; a provision in SB 21, AS 43.05.160(g),
allowed for an additional gross revenue exclusion, so 10 percent
of gross value was removed from the taxable income. However, no
leases qualify for that provision today. Only three units may
qualify in the future and those are in question.
SENATOR WIELECHOWSKI asked if the 12.5 percent royalty mostly
applies to the legacy fields.
4:14:34 PM
MR. KING answered yes.
SENATOR WIELECHOWSKI said he was trying for a fair comparison
with Texas and the consultants said the average royalty rate on
private lands there is about 25 percent.
MR. KING answered the royalty owners have been able to leverage
higher rates there, because there is a lot less uncertainty
around whether the resource exists and whether it's producing.
It is true that a new lease that is less than 10 years old in
North Dakota or Texas probably has a much higher rate, in the
20-25 percent range.
SENATOR WIELECHOWSKI asked if he would agree that Prudhoe Bay is
the largest oil field in North American.
MR. KING answered yes, and the state would be getting a much
larger share of the revenues if it had any land to lease there
now.
SENATOR WIELECHOWSKI said companies in Texas and North Dakota
are fracking and getting all they can out of the fields and then
moving on to new fields and that have a 25-percent royalty rate.
He asked him to look into that.
SENATOR WIELECHOWSKI said comparing prolific fields like Prudhoe
Bay and Kuparuk, the first and second largest fields in North
America versus a prolific field in the Permian Basin for
instance, they are paying a 25 percent royalty down there and a
12.5 percent royalty here. So, they are paying twice as much in
royalty there than they are here. Is that correct?
MR. KING answered yes. He reiterated that when these leases were
issued the knowledge of the prolific nature of those resources
was not known. Because they are contracts that endure as long as
the oil is being produced, the state does not have discretion to
now change them. If we were able to go back knowing what we know
now and issue those leases today, we would get much higher
rates.
CHAIR GIESSEL said the Pikka Unit is above the 16.6 percent
royalty line and will have the higher royalty rate and asked if
there are unleased areas around it, since a highly prospective
layer has been identified across this area. She asked what the
chances of the state increasing the royalty rate above the 16.6
percent are.
MR. KING answered those leases were issued before the resources
were known, but it was a result of leasing those lands that we
now know about those resources, so we can't change those rates.
The Pikka Unit has a higher royalty rate and when it goes into
production it will pay more revenues to the state. There is very
little unleased acreage in the area, but the Nanushuk formation
looks like it's trending to the West, and what has been seen
recently is even across the federal lands, in the NPR-A, that
trend looks like it will continue. So, there is a lot of
interest there. The Horseshoe well was drilled a year ago and
had good results, so it looks like that trend will continue.
CHAIR GIESSEL followed up that the head guy from United States
Geologic Survey (USGS) presented in Anchorage in November and
talked about that stratigraphic layer going eastward, as well.
MR. KING responded that their packets have a tract map of the
last lease sale and it indicates a few purple boxes that were
unleased acreage when the lease sale was held. Even if the trend
does extend to the east, a lot of those lands have already been
leased. Hopefully, the lessees are in a position that they can
locate those resources and develop them. But it is not as likely
that we will generate higher rates of royalty as a result of the
new information.
4:19:43 PM
SENATOR WIELECHOWSKI asked if there are any efforts in DNR to
take advantage of the world market, which is seeing these much
higher royalty rates, or is the state sticking with the 16.67
percent rate it currently has.
MR. KING answered when the department issues lease sales they
are being issued at the 16.67 percent rate. If more was known
about the resource, they would be able to charge a higher
royalty rate, but until then there is a lot of uncertainty.
Pushing the royalty rate up too high introduces the risk of not
getting a lessee. The other side of that coin is even if they
royalty rate is lower than other areas, if there is a well-known
resource under it, there should be competition around that
resource and the state should get a higher bonus bid. So,
charging a lower royalty rate is not necessarily injuring the
state, because it is still getting an increase in revenue.
4:20:59 PM
SENATOR WIELECHOWSKI said he would disagreed because the rest of
the U.S. is getting an average of 25 percent and Alaska is just
getting 16.67 percent, and from prolific fields.
The country of Norway, for example, actually goes out and does
the seismic themselves and gets the data back. They make all
that seismic information public and that drives up the interest
in the field. Is there any talk in DNR about doing that in
Alaska?
MR. KING replied that he would have to choose his words
carefully, because while being an employee of the administration
he has personal opinions, as well, but yes DNR has had
conversations on how the maximize the value of the resource. One
way that might happen is making sure to use the seismic data it
has collected over the last 10-or-so-years and making it
publicly available to generate as much interest as possible and
higher bonus bids. The option for the legislature to appropriate
money to the Division of Geological and Geographical Surveys
(DGGS) to go out and procure the state's own seismic is within
its purview and the department would support that. "We can't
make that decision ourselves."
SENATOR WIELECHOWSKI said yes you can. You can come to the
legislature say this is something we need to do. Can they expect
that from the administration or is it simply not interested in
pursuing it?
4:23:27 PM
MR. KING replied that they haven't introduced any legislation
that looks like that.
SENATOR VON IMHOF asked if a bonus payment is one-time and
royalty is on an annual basis.
MR. KING answered yes, but the royalty is based on the amount of
production and is paid monthly.
SENATOR VON IMHOF mused that it appears that the state has
seismic data that it is selling, and that it has seen it prior
to selling it. She wondered if the state would ever incorporate
that information in the upcoming special lease sales that he
mentioned earlier.
She also can't help but muse that while other states have higher
royalty payments, they also have other attributes that Alaska
doesn't have, like easy access to the resource and a nicer
climate in which to work.
4:25:34 PM
SENATOR MEYER said he was going to say the same thing. It's hard
to compare Alaska to the Lower 48 where one can work all year
round and can produce oil quicker and cheaper. There is
obviously less risk, because you know the oil is there. Where as
in Alaska millions of dollars have been spent on dry holes.
SENATOR WIELECHOWSKI countered that Alaska is one of the most
profitable places, on a per barrel basis, in the world compared
to North Dakota and Texas. When ConocoPhillips' SEC filings have
come out over the last several years, he has asked for the
numbers, and on a per barrel basis Alaska is one of the most
profitable places in the world, if not the most profitable. The
same filings indicate ConocoPhillips made hundreds of millions
of dollars here and lost a billion down in the Lower 48 over the
last few years. Comparing it to North Dakota and Texas, even
breaking out the oil, Alaska is so much more profitable even
though the climate is tougher and it's harder to do business. He
asked Mr. King, "Do you disagree? Is that contrary to what your
figures show?"
MR. KING said he needs to be careful, because any information
that is provided to DNR that is associated with the proprietary
rights of a company is confidential. He could say that one big
difference in Alaska versus another region in the U.S. like a
Bakken or Eagleford-type play, those plays require a lot of
upfront capital and have a short life. Whereas a conventional
oil play that was more typical in the 60s and 70s required a
large upfront capital investment but then had a long life. So,
the billions of dollars that were spent to develop and prepare
Prudhoe Bay for production were spent and recovered over the
last 40 years. There is an important difference between when
these different capital expenditures are recovered. So,
recovering one's investment right away versus over time can be
misleading.
SENATOR WIELECHOWSKI said since Senate Bill 21 passed, oil
production is up about 10,000 barrels, but Texas that has a
royalty rate twice as much and taxes twice as much, their
production has increased to 2 million barrels a day. North
Dakota, which has a royalty rate twice as big as ours and a tax
rate twice as much as ours has increased its production by
500,000 barrels a day. "Would you say that is something we
should look at when evaluating our tax and royalty structure?"
MR. KING replied that in these mostly political conversations,
he would as an economist suggest they do look at those numbers
and all the other factors that impact the economics of a
project. But looking at just a tax rate or any individual metric
out of context will always lead you down a path that might not
be completely accurate in the holistic view. "If you already
know the outcome you are looking for, it's very easy to find
data to support whatever decision you want to make," he said,
because it is a complex system and there is no right or easy
answer.
4:31:35 PM
SENATOR BISHOP commented that production in the Lower 48 just
goes to show what easy access will do for an oil field. On that
point, he would like to see how many companies in the Lower 48
went bankrupt in the last four years over the low price.
4:32:35 PM
MR. KING said collecting seismic information can be done through
a permit; it doesn't require a lease (slide 10). If you do have
a lease, you are called a lessee or working interest owner (WIO)
and are required to submit a "plan of operations." A working
interest owner has voting rights, contributes capital, and gets
a share of the revenues.
He said that all the permitting and the work that needs to be
done on the surface is done by the permitting section of the
DOG. When WIOs find a resource, sometimes it extends beyond
their lease borders. So, often several leases overlay the same
reservoir. Early in oil and gas law there was the "rule of
capture:" you stuck a straw in the ground along with your
neighbor who was also tapping that same reservoir and sucked as
hard as you could. More recently they have allowed for those
leases to join one another and be managed as a single lease. So,
there aren't competing property rights amongst lease holders. A
lease combined into a jointly managed agreement is called a
unit. A single unit operating agreement provides for management
of all the leases. Unitization provides for economic
efficiencies and avoids waste. If everyone is in a rush to get
as much out as they can as fast as they can, it can damage the
reservoir and leave the resource in the ground. The lease
remains in effect as long as it is in the unit. The DOG has a
Units Section that manages and ensures that the agreements are
being abided by. They also have support from the Resource
Evaluation and Commercial Sections to make sure that the plans
of development and activities that are happening within the unit
are in the best interest of the state.
4:36:45 PM
Generally, a unit has a five-year initial term (slide 12). If
the unit doesn't get to production within those five years, the
unit terminates. If they do start drilling wells, then the unit
can endure and get production, which is what the state is after.
When a resource is found under the ground, a "participating area
(PA)" is created. Ten years after the unit is created the
division has an opportunity to "contract the unit," which means
taking out leases in the unit that don't look like they are
going to contribute production.
4:37:50 PM
The units have to do plans of exploration (POE) as well as plans
of development (POD), which happen every year. It's typically
includes things like how many wells are being drilled and
facility improvements to make sure the resource is being
optimized. The Resource Evaluation Team and the Commercial Team
look at those PODs and make sure they are consistent with
prudent operations of management of the land and optimization of
the resource. If the plans are deficient, they are asked to
amend them before they can be approved. If a unit doesn't have
an active plan of development, then it can be terminated. The
plan of development is an appendix to the unit agreement and a
unit without a unit agreement has no effect, so the unit can be
terminated.
4:38:51 PM
DNR uses the term "participating area" (slide 14) to refer to a
reservoir, a pool, or field, which all have different aspects. A
PA is an area of land that has a resource that is technically
and economically viable to produce.
Within a unit each of the leases are converted to "tracts within
a unit," which are given a factor percentage, allocating the
resource back to the leases. So, within a unit one lease might
be 12.5 percent, another lease might be 16.67 percent, and
another lease might be an NPSL. It is important to know when the
oil comes out of ground where it came from for the state to get
the right amount of royalty.
MR. KING explained that when the unit is first formed, and the
participating area is first approved, the department doesn't
always know what the subsurface looks like. So, they might
create a tract factor based on aerial extents. When it starts
producing oil, models can be run to better understand what is
happening. Then they can reallocate what the tract factors
should be. This is called a "redetermination." This is rea;;y
important when a unit has either multiple owners or multiple
royalty rates.
4:40:45 PM
He said a lease is based on surface acreage and that line goes
all the way through the core of the earth. The PA is one layer
of rock, so it is possible for a lease to have participation
from multiple PAs. So, the tracts have to be allocated based on
each PA. A single lease can have contributions from multiple
PAs.
He said the department wants to make sure the state gets all it
is due, so they have an accounting and audit section. As the
companies are producing they provide reports to the division.
The accounting makes sure those reports are complete and
accurate. The lessee is responsible for maintaining books, and
the state has the right to audit them.
4:42:34 PM
CHAIR GIESSEL asked how the Alaska Oil and Gas Conservation
Commission (AOGCC) participates in the process.
MR. KING replied that AOGCC's interest is in the subsurface and
making sure that the resources are protected and not wasted. DNR
is the owner and manager of the resource, so they have a
relationship.
SENATOR BISHOP said AOGCC annually pulls a "prover ball" out at
Pump Station 1 and measures it, because that is where the
barrels flowing down TAPS are counted.
4:43:33 PM
MR. KING said there have been questions about what a Net Profit
Share Lease (NPSL) is and that 24 of them are still in effect
today. An NPSL is just like a regular lease: it has a royalty
term, a bonus bid, and a rental payment, but it has an
additional term. An example might be a lease that has one-eighth
royalty plus 30 percent of net profits. When they "reach
payout," recovering all their development costs, is when the
state starts getting the NPSL payments, as well.
4:45:05 PM
The department doesn't have to worry about allocating costs when
an entire unit is an NPSL, but the allocation becomes very
important when there is only one lease within the unit, and one
or two staff are dedicated to managing the monthly NPSL reports.
4:45:50 PM
DNR has authority from the legislature to reduce royalty rates
only in very specific instances, either when a producing field
gets to the end of its life and produces a lot more water than
oil or when a marginal project needs an adjustment to tip it
into production. He explained that at some point the 12.5
percent royalty becomes more burdensome than the value of the
resource. So, in those situations DNR is allowed to reduce the
royalty rate as low as 3 percent. Another way they are allowed
to reduce the royalty rate is if the shut-in actually did
happen, to encourage them to put it back into production.
Finally, the DNR is allowed to reduce the royalty rate at the
front end of a project in order to tip a marginally economic
project into development. Usually those terms are front-loaded
to last a year or two and once production starts the original
lease terms will be reinstated.
4:47:14 PM
CHAIR GIESSEL asked where they have given royalty relief.
MR. KING replied that DNR has two royalty relief provisions in
Oooguruk and Nikiatchuq. A third royalty relief was issued in
the Nuna development, which is also part of the Oooguruk Unit.
It expired before it reached production. So, they are expecting
when an investment decision is made, they will most likely ask
for that relief, again. Then it will have to be re-evaluated.
The legislature through statute also reduced royalty in Cook
Inlet.
4:48:08 PM
SENATOR MEYER asked if the operators of those fields he just
mentioned are Caelus or Eni.
MR. KING replied that Eni is the operator at Nikiatchuq and
Caelus is the operator at Oooguruk.
SENATOR BISHOP commented that the Nuna rate modification also
had an Alaska-hire provision.
4:48:58 PM
MR. KING said the Commercial Team does an economic analysis
(slide 18). One of their other functions is to make the decision
on whether they want the royalty in kind (RIK) or in value
(RIV). The state has the right to either receive barrels of oil
or receive the cash equivalent of those barrels. An analysis is
done looking for buyers and if a buyer is found that would
generate more revenue to the state than what the operator is
getting at that production area, they enter into a contract.
That tends to be the case with oil, because transportation
deductions are allowed back to the wellhead and that is the rate
the state uses to calculate the value of the oil. By taking
physical possession of that oil and not have to pay the shipping
cost, the state can usually generate a little bit extra revenue.
This is what the state team does when they talk to in-state
refiners. DNR's negotiating team is responsible for those
negotiations.
MR. KING said the value of the oil depends on where it was
produced in the state. Slide 20 displayed a list of price
differences in transportation costs with all else constant.
4:51:31 PM
SENATOR WIELECHOWSKI said the total numbers for NPR-A and ANWR
are the same and asked why the unrestricted general fund (UGF)
number is so different for those two.
MR. KING answered a provision in the NPR-A restricts all revenue
to the state to the NPR-A Impact Fund. The continuing resolution
that allowed a lease sale in ANWR didn't include the language
that would restrict those funds. So, the 50 percent of the
federal take that is shared with the state would flow to the
General Fund and to the Permanent Fund.
SENATOR WIELECHOWSKI said a lot of his constituents want to know
what the federal royalty rates are in ANWR.
MR. KING answered that 50 percent of the proceeds from the lease
sale that will happen in ANWR will flow to the state. Of that,
half goes to the general fund and half would go to the Permanent
Fund with the caveat that one half of one percent of that GF
money has to flow to the Public-School Trust Fund.
SENATOR WIELECHOWSKI asked why half goes to Permanent Fund in
that case instead of 25 percent.
MR. KING replied because the leases are after 1980, a statutory
provision requires a 50 percent contribution.
SENATOR WIELECHOWSKI asked if the state would get half of the
bonus lease, which it could be billions!
MR. KING responded that they hope it will be.
SENATOR WIELECHOWSKI asked if the federal royalty rate is 12.5
percent.
MR. KING said he would have to double-check.
SENATOR WIELECHOWSKI asked if the state gets half of the federal
royalty rate.
MR. KING answered yes. The company pays its royalty to the BLM
and then BLM cuts the state a check for half of what they
received.
SENATOR WIELECHOWSKI asked if they have the same provision the
state has to deduct transportation costs from the royalty.
MR. KING answered yes. He wanted to illustrate that where the
oil comes from really does matter in terms of revenue to the
state, because areas that are further away from TAPS require
more transportation and areas that are more isolated require
more costs. Additional factors will complicate this a little
bit more.
4:55:12 PM
SENATOR WIELECHOWSKI asked if he had a sense of the timeline for
the ANWR lease sale.
MR. KING answered they hope to have it together for next year,
but they have four years to get the first sale.
SENATOR WIELECHOWSKI asked if it would have to go through the
NEPA process.
MR. KING replied that no infrastructure is being developed, so
there is no actual project that would need to go through the
NEPA process right now. Once oil is discovered and someone wants
to develop it, going through NEPA is likely.
SENATOR COGHILL commented that the original agreement at
statehood was the 90/10 split for ANWR and that has been a point
of contention. Many feel that Congress unilaterally changed it.
But that is probably the deal that got it passed. He commented
we can't change it, but it seems like they can.
4:56:36 PM
SENATOR MEYER listed seven operators: Savant, Eni, Caelus,
Hilcorp, BP, ConocoPhillips, and ExxonMobil.
MR. KING added Glacier is the operator at the Badami unit, not
Savant any more.
SENATOR MEYER said it seems like we're making progress in
attracting smaller companies to Cook Inlet and the North Slope.
The number of operators has doubled. But it's still not the most
profitable and easy place to make money. If that was the case,
there are thousands of oil companies worldwide and they are all
in it to make money, and the state wouldn't have to offer tax
credits if it was that lucrative.
MR. KING added that Brooks Range Petroleum is an operator of the
Mustang Unit and they are not in production. Armstrong operates
the Pikka Unit.
SENATOR MEYER said he was referring to producing companies.
4:58:42 PM
CHAIR GIESSEL thanked Mr. King for his presentation and finding
no further business, adjourned the Senate Resources Standing
Committee meeting at 4:58 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| Senate Resources - Committee Agenda - 1 - 24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
|
| Senate Resources - Overview of Oil & Gas Leases and Royalties - DNR - 1 - 24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
Oil & Gas |
| Senate Resources - DNR Bid Form - 1 - 24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
Oil and Gas |
| Senate Resources - DNR Lease Form - 1- 24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
Oil and Gas |
| Senate Resources - Sale Notice from DNR Div of Oil and Gas - 1 - 24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
Oil and Gas |
| Senate Resources - North Slope Areawide Tract Map - 1-24 - 2018.pdf |
SRES 1/24/2018 3:30:00 PM |
Oil and Gas |