HOUSE BILL NO. 71 "An Act relating to a credit for certain exploration expenses against oil and gas properties production taxes on oil and gas produced from a lease or property in the state; relating to the deadline for certain exploration expenditures used as credits against production tax on oil and gas produced from a lease or property in the Alaska Peninsula competitive oil and gas areawide lease sale area after July 1, 2004; and providing for an effective date." WILLIAM CORBUS, COMMISSIONER, DEPARTMENT OF REVENUE, related: House Bill 71 extends from July 1, 2007 to July 1, 2010 the deadline for making qualified exploration expenditures under new AS 43.55.025 (passed in 2003) in the Bristol Bay area. Leases in the Bristol Bay (Alaska Peninsula) Competitive Oil and Gas Lease Sale are not expected to be issued prior to the spring of 2006. Production expenditures on these leases thus will most likely be made after July 1, 2007 and will not qualify for tax credits under the current law. House Bill 71 is intended to encourage exploration and development of one of the largest undeveloped onshore oil and gas fields remaining in Alaska outside of the North Slope. Development of this field has the potential to bring stable, high paying, year round jobs to an area which has traditionally relied on a seasonal commercial fishing economy. Gas from this field can provide an efficient relatively low cost energy source for heating and the production of electricity to the Alaska Peninsula area. Oil and gas development can provide transportation infrastructure and lower the cost of living in this area. Local residents and commercial interests, including native corporations in the Alaska Peninsula area support development of the gas and oil resources in this area. Under the terms of the lease sale, any development of oil and gas under state waters within the three-mile limit would have to be done by directional drilling from onshore. Three changes were made to HB 71 in the House Resources Committee substitute: 1. A change to HB 71 was added in the House Resources Committee to extend the exploration tax credit to wells drilled in the Nenana Basin through July 1, 2008. The Administration supports this amendment. 2. A second change added in the Resources Committee substitute eliminates the exploration tax credit for exploration in ANWR. 3. The third change added in House Resources eliminates the exploration tax credit for certain wells that might be considered delineation wells under the current law. The Administration does not support this change to existing tax policy. The idea behind the original bill was if an explorer was going to push the boundaries of the area under production out 25 miles, then the state would underwrite the well work associated with that exploration, even to the extent of figuring out how much production is there. All the other limits -of kinds of expense and when the work has to be done still exist. We think that was good idea then, we think it's a good idea now and if explorers thought it was a good idea, we shouldn't change the law now. These companies have made and are making decisions based on a law that was to be in effect from July 1, 2004 to July 1, 2007 it would be inappropriate to make changes to that law at this time. 2:04:20 PM Representative Hawker asked which change was not endorsed. Commissioner Corbus deferred to Dan Dickinson. 2:05:01 PM DAN DICKINSON, DIRECTOR, TAX DIVISION, DEPARTMENT OF REVENUE, (via teleconference) responded that the tax policy change made in the House Resources CS, which the Administration is not endorsing, changed the requirements and limitations on which wells might or might not qualify for the last two years of the four years from which this tax credit can apply. Representative Hawker asked for clarification on the language at issue. Mr. Dickinson replied the language is found in Section 1, lines 7-10 (new subsection 3), Section 3, 4 and 5. Under the current legislation, a 20 percent credit is set up if an exploration well is drilled more than 3 miles from an existing well. There is also a 20 percent credit if an exploration well is more than 25 miles from a unit boundary, as it existed on the date in the bill. If a company qualifies for both credits, then a 40 percent credit is possible. The CS does not allow for credit for wells that are less than 3 miles from a prior well, but more than 25 miles from a leased boundary. He gave an example. 2:09:30 PM Representative Hawker inquired about the rational behind the change. Mr. Dickinson replied that once hydrocarbons have been found, the thought is that the state should stop subsidizing and not allow any more dollars for the credit. If the boundaries are pushed out, the credit is then earned. The issue is how far the boundaries can be extended and still qualify for credit. Representative Hawker asked if there could be one or two wells in proximity to each other as part of an initial exploratory find, or if that is prohibited. Mr. Dickinson replied that the new language would prohibit that situation. HB 61 created a credit in the income tax for certain exploration and development work in the Cook Inlet. It is appropriate at times to issue a credit pertinent to the activity needed to get additional production, which is the goal. Representative Hawker noted that the line is clear in this CS between exploration drilling and development drilling. Co-Chair Meyer asked if Mr. Dickinson agreed with Representative Hawker. He replied that the definitions are based on the location of the well. 2:13:13 PM Representative Weyhrauch noted on page 2, line 6, in Version S, the word "or" appears. He recalled that the Ways and Means version had the word "and". He asked if this is a change. Mr. Dickinson thought the wording should say "and". He clarified that the Resource Committee set up three situations in subsections 1, 2, and 3. 2:16:26 PM Representative Weyhrauch referred to Section 4 and asked whether outer boundaries that have not been delineated by the required date might prevent eligibility. Mr. Dickinson explained that the lack of a unit boundary would still qualify a new well in the Bristol Bay extension area for the 20 percent credit. Mr. Dickinson recalled that if the boundary had not been delineated, you did not qualify. REPRESENTATIVE RALPH SAMUELS explained that is a policy call about the second well. In response to the question about "and" and "or", he explained that the Resources Committee switched from "and" to "or" because it didn't want anyone receiving an 80 percent credit. He opined that the wording still needs clarification. He shared discussions that happened in the Resources Committee Meeting. 2:21:26 PM Representative Holm asked about the rationale for only allowing one well. Representative Samuels explained the thinking behind the decision. The idea was not to give credit for exploration on a known property. Mr. Dickinson strongly urged that the committee adopt HB 71 be adopted with the additional conceptual language changes. 2:23:43 PM MITCH USIBELLI, MANAGER, USIBELLI ENERGY, NENANA, related that his company is involved in two projects, Nenana Basin and Healy Basin. He referred to handouts on each project (copy on file.) He shared the history of the Nenana Basin project and explained the maps in the handout. He termed this project an exciting, yet high-risk frontier exploration. He highlighted the summary sheet of Exploration Incentive Credit Programs. He noted that the sunset date on the project is 2007. 2:30:33 PM Mr. Usibelli described the history of the second project, the proposed Healy Basin exploration license. He spoke of projects delays. He described the maps in the handout. He noted that this project is a gas-only project, for coalbed methane and shallow gas exploration. The coalbed methane industry has grown rapidly and the Department of Energy's forecast is for the production of non-conventional gas to increase. He reviewed the summary sheet on Healy Exploration License Application and discussed the current timeline. 2:35:40 PM In response to a question from Co-Chair Meyer, Mr. Usibelli replied that he thinks that this tax system works. Representative Holm asked how long before data will be available on the projects. Mr. Usibelli replied that his company is processing that data now and will know more over next two to three months, by mid-summer. In response to a question from Representative Kelly, Mr. Usibelli replied that both areas' wells would be outside of the 25-mile and 3-mile limits. He added that if well is over the 30 years old the limit does not apply. 2:39:05 PM Co-Chair Chenault asked how this tax incentive is going to affect his company's coalbed methane, and oil and gas, exploration. Mr. Usibelli replied that initial exploration work would qualify for this tax credit. Co-Chair Chenault referred to the Healy Basin and asked about its size in relation to the tax incentive. Mr. Usibelli said it is his understanding that the area falls outside of the 25-mile limit. He explained that there is plenty of opportunity for exploration there. 2:41:55 PM Co-Chair Meyer suggested that a new CS be written incorporating potential amendments. He asked for information about Cook Inlet drilling. Mr. Dickinson reported that AS 43.55.025. applies to any gas or oil exploration drilling in the state and creates a four-year window. This bill expands the window for specific areas at the request of the Governor. 2:44:25 PM Representative Kelly suggested finding middle ground between the extremes of opinion surrounding this bill. He noted that he feels under-informed about the bill. Mr. Dickinson offered to provide additional information. He related that Representative Samuels summed it up earlier. Co-Chair Chenault noted that the mile limits need to be addressed and that he would be offering amendments. 2:48:56 PM Mr. Dickinson summarized that the intent is to push the boundaries of exploration. The Cook Inlet would only be able to move south. A lot of activity would be excluded that would otherwise qualify. 2:50:12 PM Representative Kelly asked for clarification on the department's position. Mr. Dickinson observed that there were several changes made. The department has no problem with the extension to the Nenana Basin. There is only one aspect that the department objects to. HB 71 was HELD in Committee for further consideration. 2:51:19 PM At ease. 3:03:56 PM