SENATE BILL NO. 192 "An Act relating to the oil and gas production tax; and providing for an effective date." JANAK MAYER, MANAGER, UPSTREAM AND GAS, PFC ENERGY, discussed a PowerPoint presentation titled "Discussion Slides: Alaska Senate Finance Committee, April 9, 2012 (copy on file). 1:47:21 PM Mr. Mayer announced that the information in the presentation was in response to questions from the committee on CSSB 192 and previous testimony. He explained Slide 2, titled "Cost Sensitivity-From April 3 Testimony and Discussion - Impact of Rising Revenue Costs." The slide graphed the "Revenue Difference Between ACES and Progressive Severance Tax Options under Different Opex/bbl Assumptions" for the producer, proposed in CSSB 192. He determined that the impact of the tax systems varied depending on the level of costs the producer incurred. He noted that the chart, originally presented on April 3, 2012 was slightly outdated since the committee recently increased progressivity from .25 to .27. The impact increased taxes for the producer at the $80/bbl. to $100/bbl. (price per barrel) range as a result of the change. He pointed out that the cost sensitivity was calculated on opex (Operating Expenditure). Capital expenses (capex) were not factored in because of the impacts of the capital credit for the producer and that typically, high cost capital expenditure was associated with new production. New production received reduced tax rates under CSSB 192. Cost sensitivity was relative to opex. He reminded the committee that the system was calibrated to be revenue neutral at $100/bbl. at average operating costs of $12/bbl. as forecast by the Department of Revenue (DOR) for FY 2013. He related BP's (British Petroleum) previous testimony that the consequence of the revenue neutral structure meant the producer incurred a higher tax burden in CSSB 192 than under ACES if the per barrel costs were higher than the average operating costs. He concurred with BP's point of view. He recapped that if opex rose as production declined and opex costs were not variable on a cost per barrel basis the result was a tax increase. 1:52:24 PM Mr. Mayer pointed out that the effect was a direct result of the committee's desire to structure a tax with more incentive for cost control and less state support for spending at high levels of progressivity "because of the interaction of high progressivity with full capital deductibility" under ACES. He exemplified a scenario under ACES where progressivity was triggered and the producer incurred a production tax rate of 40 percent, each dollar of operating or capital costs can be deducted from the production tax liability. Since the production tax per barrel also decreased the result was to move "further down the curve of progressivity." He emphasized that under ACES the costs were fully deductible from the 25 percent production tax but under CSSB 192 progressivity was no longer taxed on the net. The ability to reduce progressivity as costs escalated was lost. He believed that conclusion was the fundamental difference between ACES and CSSB 192. He reiterated that CSSB192 created a tax structure that reduced "excessive support" for rising costs and incentivized cost control. He stressed that the direct consequence of increasing incentives for cost control was higher taxes for producers with higher costs. Mr. Mayer indicated that CSSB 192 did offer a substantial form of mitigation, which was the reduced rate of progressive tax on the gross for new production in new areas and on incremental production above the decline curve. Also, companies producing in a completely new area incurred only a 5 percent tax for seven years which diminished the impact on costs. He warned that the seven year cycle limited the impact of lower taxes on higher operating costs overall. He reminded the committee that new production incurred the highest operating costs. In order to achieve cost sensitivity it was imperative that recently completed developments like Oooguruk was included under new production due to high costs well above the $12 fixed rate designated in CSSB 192. The effect reduced taxes for the first seven years. He cautioned that the reduction was offset by the full tax rate kicking in after the 7 year period. He suggested that extension or elimination of the seven year period could mitigate the impact. Similarly, mitigation was possible by reducing or excluding progressivity and simply charge the base tax. The same scenario applied to high cost incremental (new production) production from existing fields. 1:58:23 PM Mr. Mayer addressed the conclusion of the DOR testimony on CSSB 192 that sensitivity to higher costs encouraged a "further retreat to harvest mode" since companies would "face lower tax rates due to lower costs that dis- incentivized harvest production." He disagreed with the conclusion. He reasoned that as production falls operating costs were likely to stay flat and costs per barrel rose. "Harvest mode did not imply low costs per barrel." Mr. Mayer refuted DOR's assumption that tax incentives for existing production under CSSB 192 were not as strongly supported as under ACES. New capex, which created new production and was taxed at a lower rate, acted as an offset. He revealed that DOR's testimony ignored that interaction. Lastly, he contended that production volume and the resulting revenue generated was more significant than the tax rate. It would take an "extraordinary reduction in tax" to incentivize a producer to deliberately produce less revenue, especially if costs were not decreased. Mr. Mayer addressed Slide 3, "FY 2013 v Lifecycle Analysis - Impact of Costs & 7 year Time Limit." The slide reproduced slides from previous presentations from April 4, 2012 and April 5, 2012 that related to government take for new development under CSSB 192. He clarified that the slides contained seemingly conflicting data on government take. The FY 2013 data showed government take in the mid- sixties percent and the lifecycle slide in the mid- seventies percent. He explained that one analysis was based on FY 2013 and the later benchmarking data was done as a life cycle analysis. The April 4th analysis was based on FY 2013 outcomes factoring in revenue neutrality at $100/bbl. The April 5th data was based on benchmarking, which was always based on lifecycles. A lifecycle analysis used generic new development costs as opposed to North Slope average costs for FY 2013 which moved the government take upward. In addition, the FY 2013 data included the new production cap of 5 percent, which drove government take down. Mr. Mayer stated that the lifecycle analysis included the higher tax rate on new production after the 7 year, 5 percent cap expired, which increased government take. 2:04:23 PM Co-Chair Stedman surmised that one analysis was run using life cycle new production data and the other was run on FY 2013 blended numbers. Mr. Mayer agreed. Mr. Mayer discussed the slide 4: Some Goals Are Mutually Exclusive •Achieve decoupling •Reduce high levels of support for spending, and poor incentives for cost control •Minimize complexity, including need for separate cost accounting •Reduce government take on new/incremental production •No increases on any taxpayers •Revenue neutral at $100+ /bbl. •More even split between state and companies above $100/$120/bbl. He stated that the fundamental issue was that all goals cannot be achieved in any single tax structure. Mr. Mayer turned to slide 5: Some Goals Are Mutually Exclusive ACES with a 40% Cap •Achieve decoupling •Reduce high levels of support for spending, and poor incentives for cost control •Minimize complexity, including need for separate cost   accounting  •Reduce government take on new/incremental production •No increases on any taxpayers  •Revenue neutral at $100+ /bbl  •More even split between state and companies above   $100/$120 / bbl  [Items in Bold were achievable goals.] Mr. Mayer moved to slide 6: Some Goals Are Mutually Exclusive ACES with a 40% Cap & SB 305-Style Decoupling •Achieve decoupling  •Reduce high levels of support for spending, and poor incentives for cost control •Minimize complexity, including need for separate cost accounting •Reduce government take on new/incremental production •No increases on any taxpayers •Revenue neutral at $100+ /bbl  •More even split between state and companies above   $100/$120/bbl.  [Items in Bold were achievable goals.] Mr. Mayer directed attention to slide 7: Some Goals Are Mutually Exclusive HB110 •Achieve decoupling •Reduce high levels of support for spending, and poor   incentives for cost control  •Minimize complexity, including need for separate cost accounting •Reduce government take on new/incremental production  •No increases on any taxpayers  •Revenue neutral at $100+ /bbl •More even split between state and companies above   $100/$120 / bbl  [Items in Bold were achievable goals.] 2:11:04 PM Mr. Mayer addressed slide 8: Some Goals Are Mutually Exclusive CSSB192 •Achieve decoupling  •Reduce high levels of support for spending, and poor   incentives for cost control  •Minimize complexity, including need for separate cost   accounting  •Reduce government take on new/incremental production  •No increases on any taxpayers •Revenue neutral at $100+ /bbl  •More even split between state and companies above   $100/$120 / bbl  [Items in Bold were achievable goals.] Mr. Mayer pointed out that CSSB 192 accomplished all of the goals except for one; no increased taxes. He believed that the committee must consider "fundamental tradeoffs" to achieve all of the goals. He summarized the ways to mitigate increased taxes: eliminate progressivity on new and incremental production, raise the progressivity threshold, or compromise on the goal of revenue neutrality at $100/bbl. Mr. Mayer discussed Slide 9 titled, "Regime Competiveness: Relative Government Take." He spoke to previous testimony that suggested that ACES was a good system at $100/bbl. but at higher prices was problematic or that 75 percent levels of government take was a desirable goal. He shared that PFC Energy held the position that approximately 75 percent government take under ACES at $100/bbl. depicted in the ranking on slide 9, was very high by world standards. He noted the ranking was higher than any oil producer in the Lower 48 states. The Lower 48 states were faced with much lower costs, which increased its competiveness with Alaska. He observed that Norway's government take was higher but maintained a National Oil company. Norway provided active equity participation through Petoro, which ensured ongoing investment in its oil sector. He explained that instead of setting a target rate for a desired outcome, PFC Energy recommended incentivizing production. He detailed that new investment was typically accompanied by high production costs. Flexibility in government take must be built into a tax regime in order to incentivize production. He reiterated the ways to accomplish reduced government take on new production. 2:17:18 PM Senator Thomas asked for clarification regarding the chart on slide 2. Mr. Mayer responded that the chart illustrated the difference between ACES and CSSB 192 at different price levels and opex assumptions. The horizontal axis was set at zero. Any point below the zero line represented a revenue or tax decrease. Conversely, every point above the zero line represented a tax increase compared to ACES. Senator Thomas asked for a clarification on the second goal on slide 8, "Reduce high levels of support for spending…" Mr. Mayer interpreted the goal as high levels of support from the state to industry. Co-Chair Stedman exemplified that the state cannot subsidize capital expenditures at levels close to or above 100 percent. Mr. Mayer agreed. 2:21:47 PM SB 192 was HEARD and HELD in committee for further consideration.