HB 111-OIL & GAS PRODUCTION TAX;PAYMENTS;CREDITS  2:03:13 PM CO-CHAIR TARR announced that the final order of business would be HOUSE BILL NO. 111, "An Act relating to the oil and gas production tax, tax payments, and credits; relating to interest applicable to delinquent oil and gas production tax; and providing for an effective date." 2:03:48 PM COLLEEN GLOVER, Commercial Analyst, Tax Division, Department of Revenue (DOR), provided a PowerPoint presentation entitled, "Alaska's Oil and Gas Taxation - HB111\O Lifecycle Scenario Analysis," dated 2/17/17. Ms. Glover gave the committee brief personal background information. She noted the sectional analysis for HB 111 was previously presented, and her presentation would focus on lifecycle modeling that is based on two hypothetical North Slope fields and which will reveal the impacts of any tax policy on a large or small new field, including the present tax policy, identified as status quo, and the potential impacts of HB 111 [slide 2]. On slide 3, impacts by HB 111 such as the net operating loss (NOL) credit change from 35 percent to 15 percent, changes to sliding scale credits, the elimination of cash repurchases on the North Slope, the change in the minimum tax from 4 percent to 5 percent, and provisions to harden the floor, were highlighted in green. REPRESENTATIVE BIRCH directed attention to page 4 of fiscal note Identifier: HB111-DOR-TAX-02-10-17 that indicated HB 111 "raises $300 million." He asked whether the presenter would characterize the net effect of HB 111 as a major tax increase. MS. GLOVER clarified the model is a hypothetical field and the fiscal note is based on the Fall [2016 Revenue Sources Book (RSB)] forecast of projected revenues to the state. She acknowledged it is an increase and the modeling would present the impact of HB 111 on each of five scenarios. 2:07:48 PM REPRESENTATIVE BIRCH asked whether the Fall forecast recognizes the recent increased quantity of oil flowing through the Trans- Alaska Pipeline System (TAPS). MS. GLOVER deferred to the director of the Tax Division, DOR. CO-CHAIR TARR stated the $300 million referred to in the fiscal note are fiscal year 2025 (FY 25) and FY 26 estimates. MS. GLOVER explained the model assumptions are as follows [slide 4]: • development begins 1/1/18 • designed for the period of development through production not including exploration costs or abandonment costs • uses inflation of 2.25 percent per year • for status quo, producers move to non-gross value reduction (non-GVR) status and cannot go below minimum tax • for status quo, producers apply for $35 million repurchase sliding scale credits • assumes North Slope only MS. GLOVER, in response to Representative Johnson, restated the model does not include exploration costs or abandonment costs. She explained the field lifecycle modeling assumptions are as follows [slide 6]: • one 50 million barrel oil field over the life of production • one 750 million barrel oil field over the life of production • price points of $40, $60, $80, and Fall 2016 forecast price • status quo tax provisions with one or four partners • HB 111 • each scenario has a dashboard with four quadrants [slide 7]: 1. production tax; 2. state revenue; 3. producer revenue; 4. summary economics: a. total cash flows, b. net present value (NPV) analysis; c. split of profits; d. split of gross 2:13:41 PM REPRESENTATIVE BIRCH asked whether [quadrants] 1-4 include state royalty share. 2:14:09 PM MS. GLOVER said royalty is a component of state revenue, [quadrant] 2. Slide 8 illustrated a hypothetical small field over 30 project years. There was no activity in the first years and under the current tax system cash credits were generated. Cash repurchases paid to the producer by the state were shown in red. In later years, production tax paid by the producer was shown in green, and the gold line was the minimum tax. REPRESENTATIVE BIRCH questioned whether the model assumes the state honored its commitment to the explorer in the amount of $150 million. MS. GLOVER said the model assumes $35 million per year would be paid by the state. She turned attention to the four components of state revenue: production tax shown in green, property tax shown in red, royalties shown in blue, and state corporate income tax shown in purple. On the North Slope, the state gets a 7.5 percent share of property tax [slide 9]. REPRESENTATIVE BIRCH recalled the state collects 20 mills in property tax statewide, and reimburses communities along the pipeline for their share. He opined property tax for the state is a significant amount. 2:17:27 PM MS. GLOVER explained the property tax shown is for the hypothetical field. However, 92.5 percent goes to municipalities. She returned attention to slide 9 that illustrated income tax is paid after producers begin to make a profit. Slide 10 illustrated cash flows for producers over the duration of the field, beginning with huge net operating losses and followed by production. Slide 11 summarized economics during the life of the project: lifecycle totals with rates of return; split of profits based on entity such as the state or municipalities; split of gross by entity. She pointed out state net present value (NPV} is 6.95 percent and producer cash NPV is 10 percent. Ms. Glover presented the small field modeling assumptions, noting that any changes can be easily accommodated [slide 13]. CO-CHAIR TARR questioned why the state corporate income tax rate is lower than in statute. MS. GLOVER said the rate is 6.5 percent of the net. Slide 14 illustrated the production profile curve for a small field, showing almost $200 million in capital investment before production begins at year four. However, operating expenditures correspond with the production curve. 2:24:18 PM REPRESENTATIVE JOHNSON asked what taxes are being paid at the beginning of development. MS. GLOVER said none. REPRESENTATIVE BIRCH noted total capital expenditures shown on slide 14 are $500 million before production. MS. GLOVER agreed. Slide 15 illustrated the four modeling components for a small field under the current tax regime that were previously discussed on slides 8-11. In the small field model it was assumed there would be no production until year four, and thus no production tax or royalty revenue is due the state until year four. Total net gain to the state for the life of the hypothetical field was $870 million and net cash flow to the producer was $815 million. REPRESENTATIVE BIRCH returned attention to slide 15, and asked for clarification on the total amount of credits and capital spend. 2:29:37 PM MS. GLOVER responded slide 14 was a representative profile and slide 15 illustrated the actual scenario. In further response to Representative Birch, she said in the aforementioned scenario the lifecycle total credits that were purchased are $161 million. Ms. Glover presented slide 16 which illustrated the small field model under the proposed HB 111 tax regime. As shown in the upper left graph, there are no cash repurchases and the producer pays the minimum tax; as shown in the upper right graph, there is no revenue to the state until production begins; as shown in the lower left graph, there is little change; as shown in the lifecycle totals, production tax remains the same as adjusted for net present value. REPRESENTATIVE RAUSCHER asked whether royalty was increased in slide 16. MS. GLOVER answered royalty is not impacted by HB 111. Slide 17 illustrated cash flows for the small field, one partner scenario, at $40, $60, $80, and Fall 2016 forecast prices, under the status quo and HB 111. 2:35:01 PM CO-CHAIR TARR surmised at $40 companies have higher losses under HB 111 due to the price of oil [from the point of development]. 2:35:19 PM MS. GLOVER provided additional data on the eight small field scenarios under the status quo and HB 111 [slide 18]. Ms. Glover presented the large field modeling assumptions [slide 20]. She explained the production profile differs as production for a large field is assumed to begin at year five, however, similarly to the development of a small field, there is a large capital investment in the first years, followed by peak production and declining production [slide 21]. Modeling for the large field included three scenarios: current tax policy [status quo], one partner with annual $35 million maximum repurchase; status quo, four partners; HB 111 with one to four partners. As shown on the slide 22 upper left graph, cash repurchases are received for the first seven years, minimum tax is paid to about year twelve or thirteen, and higher production tax is paid in the following years; because of early losses, the producer carried forward tax credits to use against tax liability, and when the NOL credits are exhausted, production tax greatly increases. As shown in the upper right graph, state revenue also peaks around year twelve. As shown in the lower left graph, positive cash flow begins around year eight. CO-CHAIR TARR observed in the foregoing scenario, the producer chose to use its $35 million in credits, and carried the remaining credits forward. MS. GLOVER said DOR assumed the producers would opt to carry forward credits for their full value rather than taking 75 percent cash value. REPRESENTATIVE RAUSCHER asked whether the model is based on an average historical lifecycle of a production field. MS. GLOVER said the model is based on a production profile curve developed by DOR and the Department of Natural Resources (DNR), looking at natural field production profiles and working with tax consultants. She further explained the large field assumes 750 million barrels over the life of the field, so the profile curve estimates percent of production by year. She returned to the presentation, noting slide 23 illustrated the large field with four partners, which qualifies the project for the $140 million per year cash repurchase maximum and impacts GVR credits. As shown on the slide 23 upper left graph, state repurchased credits are bigger, and production tax is paid earlier, however, the total tax paid to the state is unaffected. 2:42:14 PM CO-CHAIR TARR directed attention to the amount of $1.6 billion in repurchased tax credits, based on the large field scenario with four partners. MS. GLOVER presented slide 24 that illustrated a large field scenario with one or four partners under HB 111. As shown on the upper left graph, there are no tax repurchases, tax payments begin at year five at production, the producer pays minimum tax until exhausting NOL credits, and pays the full production tax for the remainder of the life of the field. As shown on the upper right graph, the state does not receive revenue until production begins. CO-CHAIR JOSEPHSON returned attention to slide 23 - which illustrated a partner or joint venture with a large field - and noted the lifecycle of tax credits repurchased under current law is $1.6 billion and the state nets $22 billion. MS. GLOVER said correct. CO-CHAIR JOSEPHSON acknowledged this is a high rate of return albeit over a long period of time. Considering the all of the variables such as price, the state should know the quality of its investment. He questioned how residents of the state can be assured of a worthy investment. MS. GLOVER said that is not her expertise. REPRESENTATIVE RAUSCHER asked what part of the model incents the production of an oil field. MS. GLOVER advised the model is designed to show the impact made by HB 111 on a hypothetical field, and does not predict activity or decisions by producers. CO-CHAIR TARR said the upper left graphs on [slides 15, 16, 22, 23, and 24] show the changes in "incentives" because of the changes to the repurchase cash credits, which are one of the current incentives in tax policy. MS. GLOVER advised there are analyses in this regard later in the presentation. Slide 26 provided additional data on the eight large field scenarios under the status quo one partner, status quo four partners, and HB 111, and slide 27 was an outline of all of the scenarios that were modeled on the large field. 2:48:57 PM REPRESENTATIVE JOHNSON pointed out the economics of a large field are better than those of a small field, and opined increased exploration on smaller fields was the purpose of Senate Bill 21 [passed in the 28th Alaska State Legislature]. CO-CHAIR TARR compared the summary on slide 18 for small fields to the summary on slide 26 for large fields, and pointed out producer cash flow at $40 is negative for small fields - but is not for larger fields - due to economies of scale. MS. GLOVER noted from the results of the model DOR sought to determine how the five components of the tax drive changes to the state and to the producers. For example, DOR completed an analysis on the five components using Fall 2016 forecast price on a large field with one partner, compared to HB 111 [slide 27]. Slide 28 illustrated the tax changes made by HB 111 in state net cash flows. The biggest difference was made by changing the NOL credit from 35 percent to 15 percent, which was a gain of $2 billion. Additional impacts are a gain of about $1 billion from changes to the sliding scale credit, and a gain of about $25 million from hardening the floor. Other changes are insignificant to cash flows. CO-CHAIR TARR restated the analysis is over the lifecycle of the modeled field, thus the total potential earnings are approximately $22 billion, and the total potential change for the life of the field would be the aforementioned $2 billion and $1 billion. MS. GLOVER added on slide 28 the blue bar on the left represents approximately $22 billion in net cash flow for the status quo, and the purple bar on the right represents net cash flow earned under HB 111. Slide 29 illustrated the difference by HB 111 in state net present value (NPV), incorporating the time value of money over the lifecycle of the field. The biggest impact of HB 111 was again changing the NOL credits from 35 percent to 15 percent; the sliding scale credits, hardening of the floor and other changes have smaller impacts. Eliminating cash repurchase has no impact. Slide 30 illustrated the difference made by HB 111 in producer net cash flows: status quo for the producer was about $18 billion in cash flow, changing NOL credits from 35 percent to 15 percent was a reduction of about $2 billion, and the change in sliding scale credit was a reduction. Slide 31 illustrated the difference by HB 111 in producer NPV. Under status quo the producer is at a negative NPV and changing NOL credits has the biggest impact; sliding scale credit, hardening the floor, changing the minimum tax, and eliminating cash repurchase have further impacts. 2:55:40 PM CO-CHAIR JOSEPHSON inquired as to the price forecast that was used on the model for slide 31. MS. GLOVER said the Fall 2016 RSB forecast was used. In further response to Co-Chair Josephson, she explained there are no cash credits reflected in slide 31. MS. GLOVER, in response to Co-Chair Tarr, further explained the status quo of the producers is negative in slide 31 because of the time value of money. Slide 22 indicated the same negative NPV due to the outlay of money in the beginning of a project, which is shown in 2018 dollars. REPRESENTATIVE PARISH surmised there was a 10 percent rate of return on other funds. MS. GLOVER said correct. [HB 111 was held over.]