SB 130-TAX CREDITS;INTEREST;REFUNDS;O & G  [Contains discussion of HB 247.]  3:45:00 PM CHAIR GIESSEL announced consideration of SB 130 and invited Mr. Alper to continue the Department of Revenue's presentation that will begin on slide 31. ^Continuation of DOR overview of Alaska Oil and Gas Tax Reform RANDALL HOFFBECK, Commissioner, Department of Revenue (DOR), Juneau, Alaska, said Director Alper will continue the presentation, but he was available for questions on SB 130. KEN ALPER, Director, Tax Division, Department of Revenue (DOR), Juneau, Alaska, said slide 31 has the title "Impact on Specific Industry Sectors." Slide 32 points out how particular sectors of the oil and gas economy would be impacted by the specific provisions of the bill at different price points. He said the provisions of SB 130 do not impact the North Slope major producer at higher prices (generally above $85/barrel where the minimum tax kicks in). Below that level is where the minimum tax tends to take precedence over the 35 percent net tax. The bill attempts to raise the minimum tax from 4 percent to 5 percent. In a period of very low prices such as now, and especially into a second consecutive year, the issue of using net operating loss (NOL) credits to reduce payments below the minimum tax floor comes into play, and SB 130 would prevent that from happening. It would cause those additional NOL credits to be rolled forward and be added to the stack of NOL credits for use in a future year after the price has recovered. CHAIR GIESSEL asked at what price the 12.5 percent royalty begins to spiral upward to over 100 percent. MR. ALPER answered that happens when the profits begin to be very constrained at anywhere less than $50/barrel. 3:48:23 PM SENATOR STEDMAN asked what taking the floor from 4 to 5 percent means in dollars and what the trigger point is to get out of it. At some point, he also wanted a discussion on the per-barrel sliding credit when the floor gets triggered, which the Senate hadn't heard, because it was put in by the House. He also wanted to know if they had NOL credit figures for FY15/16/17 and what the expectations are for them getting paid off. MR. ALPER explained that he would try to "unpack" Senator Stedman's questions. First off, he would deliver details of raising the floor from 4 to 5 percent and the trigger point in his follow-up presentation tomorrow, but under the current system, $78 is the cross-over point of existing the minimum tax. Because of the way the cost and tax curves work the higher the minimum tax gets, the higher the cross-over gets. It's in the high $70s at the 4 percent level and it will be in the $80s at the 5 percent level. The fiscal note to the original bill did not delve into stacking up of net operating loss (NOL) credits, because the numbers didn't became apparent until the spring revenue forecast. An updated fiscal note currently attached to the House companion bill, CSHB 247, has numbers for both the original bill and the amended bill. Hardening the floor raises revenue by $150 to $200 million a year at these prices, but the NOL that is forced to be carried over due to the floor hardening and raising goes up to about $700 million in a couple of years and to about $1.5 billion by 2019/20. SENATOR STEDMAN followed up saying a verbal answer is kind of okay, but it would be beneficial for the committee to see the current NOL operating and capital numbers for FY16/17 on paper. Lawmakers, as policy makers, need to clearly recognize the magnitude of what they are dealing with. He also needs help with how much of the non-deductible capital costs are applicable to the carry-forward credits, and a clear understanding of how Cook Inlet and Middle Earth are being treated differently than the North Slope. MR. ALPER said Mr. Stickle was back in the office taking notes as they speak, and the stacking up of the NOL credits is in the most current fiscal note, which is on BASIS. He clarified when he says $700 million or $1.5 billion, that's in credits - after the multiplication of whatever the much larger loss was, multiplying times the credit percentage. 3:54:19 PM Slide 33 shows that the North Slope new or smaller producers that have built the newer fields will see no change at higher oil prices, but a more substantial impact below the 85 percent range. Because of the nature of the GVR, the new oil tax provisions of SB 21, their per-barrel credit is allowed to drop taxes to zero (the production from those fields is not susceptible to the minimum tax). SB 130 attempts to harden the floor by making new oil susceptible to the minimum tax, as well. So, effectively there is an increase in some cases from a zero to a 5 percent gross tax that would substantially impact the smaller producers more than the major producers. Likewise, if the company is an operating loss, the gross value reduction (GVR) that is used for the benefit of new oil cannot be used to increase the size of an NOL. The intent is that the NOL would be limited to 35 percent of the actual cash flow loss and not the more synthetic calculated loss that includes the GVR. SENATOR STEDMAN asked if a company has a $27 million credit for FY17, if any interest accrues. How is it treated once it exists and is not turned into cash? MR. ALPER answered that he wasn't sure what provision he was referring to, but the floor hardening and the requirement of having an operating loss carry forward for the major producers is very much deferring of an obligation (because it would still need to be issued; the deductions would simply be taken in a future year), but the third bullet on slide 33 would be the elimination of a benefit (it would not roll forward). If that number is $27 million, it means that the companies in question would have an operating loss credit that would be $27 million less than it would be if they were able to use the GVR in that calculation. 3:57:10 PM Slide 34 talks about the impacts to a new project developer on the North Slope building its first oil field but not currently producing oil and gas. The NOL credit is baked in at 35 percent as a provision of SB 21. That is not changed. The credit is earned, and the question then becomes how to cash it out. Here there is a little fork in the road. If it's a large company with global revenues in excess of $10 billion, the state won't cash out that credit. They can sell it to another company or they can hold it until they have a liability. For the smaller companies with revenues below $10 billion, an annual cap of $25 million per company that would be paid out in a single year is being proposed. Any credits in excess of that number would be effectively rolled forward to a future year and continue adding to the stack of unpaid credits. SENATOR STEDMAN said he assumed they would see some modeling on credits under both the current statute and under the proposed changes, so they can visualize how the treasury was going to deal with the NOLs two or three years out. MR. ALPER said he is talking about two different stacks of NOLs: the ones that are not refundable, because they are owned by the major producers, a number that gets quite high, and the earned credits that are cashable, but capped annually, stacking up alongside them. He would bring a slide tomorrow that would put some numbers on it. He explained that the fiscal note has a negative number in savings in some years. That is the result of credits being earned in one year and the state saving money by not cashing them out since cashable credits are capped at $25 million/year, roll forward to be paid out in another year. However, there are circumstances in years three or four, based on available information, when the state is cashing out more credits than it otherwise would have under the status quo, because some of the older ones that rolled forward stack up on top of each other. SENATOR STEDMAN rephrased his previous question; when he talked about the creation of NOL carry forwards, he was talking about companies with less than $10 billion in one category and the others in another category, but the Revenue Sources Book lumps them all together. MR. ALPER said he will provide those numbers to him, and the Tax Division would help get him whatever he is looking for. 4:02:13 PM He explained that in Cook Inlet, (slide 35) the existing producer who is selling oil and gas generally to the Anchorage bowl and the Southcentral utility market is paying low to zero taxes due to the tax caps that have been in place since 2006 and will be there through 2021. Those companies are currently eligible for repurchase of their QCE and WLE credits in the 20- 40 percent range. A typical project is around 30 percent, so the state is effectively paying 30 percent of that spending. SB 130 repeals those specific credits. In a broad sense if a company is not in an operating loss situation, it's perfectly reasonable that they pay zero tax, but refunding the credits to the company that is paying zero tax while earning a profit seems a little bit unnecessary, or possibly even excessive, given the state's current fiscal situation. They are not looking to touch upon the tax caps themselves, which remain on the books through the end of 2021. 4:03:46 PM Slide 36 captures the new Cook Inlet field developer that currently gets a 25 percent NOL credit that gets stacked along with what he described for the producers in the previous slide. Those two credits taken together tend to mean the state is providing reimbursement in the neighborhood of 50-60 percent for ongoing work in the Cook Inlet right now. By repealing those capital and well credits, the intent of the legislation is to reduce the state's level of ongoing support to 25 percent. MR. ALPER explained that the 50 percent level seems excessive given the fiscal realities and the need to prioritize. The choice was made to prioritize the operating loss credit and continue the support at 35 percent. Of that 25 percent NOL credit, the same limitations on repurchase kick in as those on the previous slide. The larger companies, should that kind of multi-national be operating in Cook Inlet, would not be able to cash those certificates and the smaller companies would be limited by the $25 million annual cap. Everything in excess of that gets carried forward. 4:05:17 PM Slide 37 covered the Interior/Frontier area, or Middle Earth, that is getting 65 percent credits for exploration. That means the 40 percent exploration credit under most circumstances and a 25 percent NOL. In development they are in the same paradigm as the Cook Inlet folks: the 25 percent NOL plus the weighted average of the capital and well credits. By repealing the capital credits the developer, once they are proven and have found something, fall under the same 25 percent category that the Cook Inlet developer does. However, because there is a need to find that resource in the first place and because there has been a previous legislative decision made to encourage people to find and explore for oil and gas in the Interior basins, the exploration credits have been previously extended through 2022. That is not being touched in the legislation before them, which means the state will continue to support exploration work at the 65 percent level in Nenana and Glennallen. 4:06:25 PM SENATOR COGHILL said these credits have been pretty much dormant and the expectation is the other credits that apply within the Cook Inlet have been more valuable. MR. ALPER said these credits are the ones that have been used. The dormant ones are the super credits (80 percent for the Interior and 75 percent for seismic) that were created in 2012 and those are scheduled for sunset. Although one explorer, the Ahtna Corporation, has talked about an extension. SENATOR STEDMAN asked what other basins are doing in response to the lower prices and what kind of credits or fiscal health they have extended to the industry over the last several years. He also wanted some comparative work done on Texas or North Dakota. CHAIR GIESSEL replied that enalytica had responded to similar questions in other committees and she would ask them to provide that information to this committee. SENATOR COSTELLO wanted to know the driving principles behind SB 130. COMMISSIONER HOFFBECK explained that they looked at the credits in three categories: ones that weren't used, ones that were used differently than intended, and ones that had worked well. The ones that didn't work the way they were intended were either credits that weren't used or when the focus of the use was not where it was intended. A prime example is some of the Cook Inlet Recovery Act credits that were put in place to try and deal with energy security in Southcentral Alaska, but were equally applied to oil exploration and development. Everything was done to preserve the Net Operating Loss Credit, but with some caps on it. There are no taxes on oil in Cook Inlet and there is no energy security issue there now, either. SENATOR COSTELLO asked if the administration's other revenue generating bills have an overall driving principle. Were decisions made based on modeling that was done first? COMMISSIONER HOFFBECK answered that the entire reason behind these bills is revenues and being able to afford the credits. 4:11:27 PM SENATOR WIELECHOWSKI said the real behavior they have tried to incentivize is gas exploration in Cook Inlet, the Interior and the frontier areas to have gas for local communities, but what seems to be happening is that a lot of money is being used for oil exploration and development and asked if it is possible to develop a system that provides incentives for gas only? MR. ALPER answered it's doable. They started looking at it this year when the question started to be asked about the oil versus gas split. The department looked through historic Cook Inlet credits and came up with roughly a two-thirds/one-third metric. Sometimes it's a question of the bill's construction; it has to be worded in a way that focuses on gas. That is when the drafters get nervous, because there is a tendency "to not ring- fence." It's similar to cost allocation issues on the North Slope and why the gross value reduction is structured the way it is as part of gross rather than part of net. The most technically complicated maneuver is how to divide up the lease expenditures. In some ways, it is a more solvable problem in Cook Inlet because the taxes are already broken out by field (it's a multiplier by field), more like the ELF was structured on the North Slope in the past. It's a challenge, but it's not impossible, he said. SENATOR WIELECHOWSKI asked for rough numbers on how much the state would save if they would allow the continuation of gas credits but not oil credits in Cook Inlet. MR. ALPER answered that the overall savings would be about one- third of that amount because about two-thirds of the money is currently supporting gas. That changes from year to year and scenario to scenario. COMMISSIONER HOFFBECK said this has almost become a backward looking analysis of the credits, because going forward when people look for gas, sometimes they find oil and vice versa, and generally they find them together. So, there would have to be some kind of allocation of the credits based on the productions. 4:14:21 PM MR. ALPER said slides 38 & 39 are a very high level summary of some of the fiscal note information for both the original version and the latest modifications based on the spring forecast. So, at the time they introduced the bill they estimated it to be about a $500 million piece of legislation, at least in its initial year. Of that, about $200 million in reductions comes from the repeal of certain provisions as well as the elimination of "loopholes or unforeseen circumstances in statute." A second $200 million comes from deferred payments on credits. The great bulk of that was in the $25 million caps and similar provisions that said companies are going to be earning certificates but the state was not going to be fully funding them in the first year. A couple of other provisions fall in that category. Finally, there is additional revenue in the neighborhood of about $100 million between strengthening the minimum tax, which was worth about $50 million, and then the increase to 5 percent from 4 percent brings in about another $50 million. MR. ALPER said a little bit of additional revenue comes from the proposed interest rate reform, but interestingly, only the revenue from non-oil and gas taxes. He explained that the interest rate statutes are in the general revenue statutes that apply to all 24 taxes. If that change is made and the state gets a little bit more interest money from a cigarette tax or a corporate income tax, that show up in the fiscal note going to the General Fund (GF), but the oil and gas tax assessments end up going into the Constitutional Budget Reserve, so they aren't in the fiscal note as going to the GF. MR. ALPER said the department did a much more granular model once they had the spring forecast and prepared a fiscal note in a table format more comparable to what the previous administration did during the SB 21 hearings and this model is very much a work in progress. Based on that and the latest information on some revised company spending information including in Cook Inlet, the actual elimination part was only going to eliminate about $50 million a year at first, but then the deferral went up to $550 million. This is from a lot of ongoing work in larger projects that would get capped at the $25 million level. That's about $600 million in immediate revenue savings with some of that rolling into future years. A big reason for the jump in NOL credits is that some companies were losing more money than they thought they were going to lose. A second big reason, which took them a little bit by surprise, was that the exploration numbers for last year were far larger than originally anticipated. And that is simply because of the credit sunsetting. If people were planning on exploration work in the next five or 10 years, it was worth their while to front-load that work and get it done now, because on the North Slope, in particular, the state has 85 percent credit support for exploration work. Companies leapt at the opportunity. Meanwhile, on the revenue side, Mr. Alper said, hardening of the floor would bring in about $185 million, about $50 million more than thought, mainly because more of the major producers have operating losses and will therefore pay more money above that to get to the minimum tax that the department had calculated six months ago. 4:18:10 PM Now the state is seeing a bill of well over $700 million, although that number drops off dramatically in the next couple of years. Part of that is because of the inadequacies of their credit forecasting. They simply don't know what companies are going to be doing workwise two or three years from now, because the companies themselves don't know. The department uses the same somewhat conservative methodology that goes into its production forecast based on what companies tell them. They go out to them twice a year and ask what wells they are going to drill and what projects they are going to do and try to build that into some sort of a forecast both of spending and revenue production. It's all tied together in the same data set along with the credit forecast. 4:18:38 PM SENATOR MICCICHE joined the committee. MR. ALPER said the bill was written with an effective date of July 1, 2016, essentially next fiscal year, but honoring all existing credits meant they would be paid in full prior to the effective date, and the department wants to make sure there is adequate funding to pay for those credits before messing around with any caps or changes. He recapped that there is the $200 million through the credit veto from the previous session when the Governor limited the credit repurchase to $500 million. The department's revised estimate for FY17 is $575 million in credits ($575 million plus the $200 million carry over) that will be fully paid before any of the provisions of the bill kick in. Anything earned in the first half of this calendar year prior to the effective date would also come in under the old system, and therefore, enough money is needed to pay those. The bill contemplates a $1 billion transition fund in a one-time appropriation to the Tax Credit Fund. The number $926,575,000 is in a fund cap fiscal note attached to this bill. There is no magic to that number; it is simply the difference between the $73.4 million in the operating budget and around $1 billion. The expectation is, were the bill fully implemented as written, the annual cost of refundable tax credits would be in the neighborhood of $100 million and could be part of the regular appropriation process going forward. 4:20:47 PM SENATOR STEDMAN asked the difference in making the effective date of July 1, 2016, January 1, 2016 or January 1, 2017, since January 1, 2016, is extremely retroactive. COMMISSIONER HOFFBECK responded that the thought process on a fairly immediate effective date was to prevent a flight to credits with a January 1, 2017 effective date. They have heard a lot of testimony in the last few committees about the importance of the summer season particularly in Cook Inlet, and the July 1, 2016 effective date may have been too aggressive. Having the retroactive effective date was not seen as being useful in the process. MR. ALPER added that he got some push back from his staff based on changing anything in other than a calendar year. He explained that for parts of the bill that are referred to when a credit is earned for an activity (capital credit, for example), any date on the calendar is fine as long as they get the work done and can effectively show receipts. However, those that impact the overall tax calculation - changes to operating loss credits and that sort of thing - is where there is tremendous resistance to anything other than a calendar year based change, because of the nature of the production tax filings. There have been a couple of years when the department had to effectively split a company's tax returns in two and do them both in parallel, because of a tax change in the middle of the calendar year. SENATOR WIELECHOWSKI asked if the state would be honoring the existing estimated $625 million in credits to be earned and payable in FY17. COMMISSIONER HOFFBECK answered that those credits were already earned in CY15 and come due on July 1, 2016, which is FY17. 4:24:05 PM MR. ALPER said slide 44 shows how this fits into the Governor's overall fiscal plan. He explained that the Governor introduced 10 bills at the beginning of this session: 8 traditional tax bills: the income tax, the 3 consumption taxes (tobacco, alcohol, motor fuel), 3 business taxes (fish, mining, and the cruise ship head tax), plus the Permanent Fund Protection Act, and the Alaska Industrial Development and Export Authority (AIDEA) loan bill. The intent of those bills taken together with the budget cuts were proposed to balance the budget for FY19 - to transition the state from the structural deficits it is in now to something where it can consistently have a balanced budget in place by two years from now - based on projections, at least, at the time last fall when they were putting this together. This broader package, specifically this tax credit, is looking at some sort of certainty. Industry knows the current situation is unstable and they know something is going to change. The administration wants to change it and get it over with and let them have a little bit of certainty going forward. Likewise, Mr. Alper said, the governor's fiscal plan offers some funding certainty to the financing community if there is a big delta between what the state is offering in credits and what it will be able to repay. They learned that last year with just the line item veto and it could potentially get a lot worse if the situation doesn't get better. Meanwhile, as the state is withdrawing some support for ongoing development, they thought this companion AIDEA loan bill (SB 129) would be an important feature. It creates a fourth fund at the AIDEA to concentrate on oil and gas development loans. MR. ALPER said that AIDEA has given loans in the oil and gas industry; it invests throughout Alaska's economy. But the Revolving Loan Fund attempts to be a diversified portfolio that touches upon all sectors of the economy. Oil and gas loans tend to be quite large and a diversified portfolio could very easily become unbalanced with them. The thought was to create a new fourth fund in addition to the Revolving Loan Fund, the Energy Transmission Fund, and the Arctic Infrastructure Fund. Quite specifically, development loans are for proven reserves not exploration. They envision that the resource, itself, the value in the ground, would be part of the collateral that could be offered on those loans. A fiscal note capitalizes the fund with $200 million to make the first loans. One of the features in that legislation is that all repayments could be deferred for several years, the idea being to make a loan for building an oil field, for instance, which might take five years. Once it is in production, they would be able to start making payments, and it's a revolving fund so that money could come back and be used to make other loans. That is how the fiscal plan ties together with SB 130 as one of the 10 pieces. 4:27:53 PM Meanwhile the DOR must administer all of this. It has a fairly complex and comprehensive Tax Revenue Management System that is in its final stages of development. Its portal is called "Revenue Online" and it allows for online filing. All of the tax types are currently functional within what is called "TRMS." He thanked the legislature, particularly Senator Stedman, who chaired Senate Finance at that moment in 2011 when $34 million got appropriated to buy the system. It has been very much a successful software megaproject for the State of Alaska. So, talking to the software developer about the legislation and the many changes before them, they are estimating it will take a little over $1 million in a one-time cost - for programming, testing, and use of staff. They don't anticipate any additional changes to administer the program; staffing needs will not change. A fairly robust amendment process will start this summer to implement any changes in this legislation as well as some other oil and gas regulatory changes that have been building up over the last couple of years. 4:29:31 PM Finally, he said, all their presentations are out on BASIS where staff has access to them. 4:30:27 PM SENATOR STEDMAN remarked that the Senate had never been asked to look at other committee presentations before, particularly ones in the House. MR. ALPER said he would provide the presentations to Chair Giessel so that they could be put online as part of this committee's record and be easy to find for everybody. CHAIR GIESSEL, finding no further questions, said SB 130 would be held in committee.