HOUSE SPECIAL COMMITTEE ON OIL AND GAS March 14, 1995 10:06 a.m. MEMBERS PRESENT Representative Norman Rokeberg, Chairman Representative Scott Ogan, Vice-Chair Representative Gary Davis Representative Bill Williams Representative Tom Brice Representative Bettye Davis Representative David Finkelstein MEMBERS ABSENT All members present COMMITTEE CALENDAR HB 207: "An Act relating to adjustments to royalty reserved to the state to encourage otherwise uneconomic production of oil and gas; relating to the depositing of royalties and royalty sale proceeds in the Alaska permanent fund; and providing for an effective date." HEARD AND HELD HO&G - 03/14/95 HB 209: "An Act relating to the authority of the commissioner of natural resources to allow reductions of royalty on oil and gas leases; and providing for an effective date." SCHEDULED BUT NOT HEARD WITNESS REGISTER JOHN SHIVELY, Commissioner Department of Natural Resources 400 Willoughby Avenue Juneau, AK 99801 Telephone: (907) 465-2400 POSITION STATEMENT: Discussed HB 207 KEN BOYD, Deputy Director Division of Oil and Gas Department of Natural Resources 3601 C Street, Suite 1380 Anchorage, AK 99503-5948 POSITION STATEMENT: Discussed HB 207 DAVID JOHNSTON, Chairman Alaska Oil and Gas Conservation Commission 3001 Porcupine Drive Anchorage, AK 99501 POSITION STATEMENT: Discussed HB 207 PREVIOUS ACTION BILL: HB 207 SHORT TITLE: ADJUSTMENTS TO OIL AND GAS ROYALTIES SPONSOR(S): RULES BY REQUEST OF THE GOVERNOR JRN-DATE JRN-PG ACTION 02/27/95 501 (H) READ THE FIRST TIME - REFERRAL(S) 02/27/95 501 (H) OIL & GAS, RESOURCES, FINANCE 02/27/95 501 (H) FISCAL NOTE (DNR) 02/27/95 501 (H) 2 ZERO FISCAL NOTES (DNR, REV) 02/27/95 501 (H) GOVERNOR'S TRANSMITTAL LETTER 03/08/95 665 (H) CORRECTED FISCAL NOTE (DNR) #3 03/09/95 (H) O&G AT 12:00 PM CAPITOL 17 03/09/95 (H) MINUTE(O&G) 03/14/95 (H) O&G AT 10:00 AM CAPITOL 124 BILL: HB 209 SHORT TITLE: OIL & GAS ROYALTY REDUCTION SPONSOR(S): REPRESENTATIVE(S) GREEN,Rokeberg JRN-DATE JRN-PG ACTION 02/27/95 503 (H) READ THE FIRST TIME - REFERRAL(S) 02/27/95 503 (H) OIL & GAS, RESOURCES, FINANCE 03/01/95 551 (H) COSPONSOR(S): ROKEBERG 03/09/95 (H) O&G AT 12:00 PM CAPITOL 17 03/09/95 (H) MINUTE(O&G) 03/14/95 (H) O&G AT 10:00 AM CAPITOL 124 TAPE 95-9, SIDE A Number 000 HO&G - 03/14/95 HB 207 - ADJUSTMENTS TO OIL AND GAS ROYALTIES CHAIRMAN NORMAN ROKEBERG: called the House Special Committee on Oil and Gas to order at 10:06 a.m. For the record, committee members present are, Representative Tom Brice, Representative Gary Davis, Representative Bettye Davis, and the Chairman, myself, a quorum is present. On today's calendar is a continuation our meeting from last week, last Thursday that is, March 9, 1995, on HB 207, the royalty reductions for oil and new fields. If I could ask Commissioner Shively to come forward -- and perhaps Mr. Boyd also, if you want to, if that's convenient -- why don't you pull a chair up there, sorry about that. If you would be so kind, gentlemen, as to clearly state your full names, affiliations, and titles for the records please. Good morning to you. Number 030 JOHN SHIVELY, COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES: Good morning Mr. Chairman my name is John Shively. I'm Commissioner of the Department of Natural Resources. Number 031 KEN BOYD, ACTING DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES: Good morning Mr. Chairman, and I'm the Acting Director for the Division of Oil and Gas. Number 032 CHAIRMAN ROKEBERG: Commissioner, is there any particular things you would like to start out with this morning that would help clarify any of the testimony of last week, or anything that has come up in the interim that you would like to make an opening statement? Number 038 COMMISSIONER SHIVELY: Yes, Mr. Chairman, if I might. We had a fairly lengthy discussion last time of whether or not we could deal with a pool of oil that was at a different level or horizon in -- that was over -- a field that was currently producing, and I think I led the committee to believe that we felt that this legislation would allow us -- in fact, I know I led the committee to believe that we felt that the legislation would allow us to do that. We have gone back and looked at that and have decided that we really can't do that. That was just some of my own lack of familiarity with how oil fields are structured. We, if it is the committee's desire to want to deal with separate pools under leases that are part of a producing field, we can provide language to the committee that would allow the legislation to cover that, and we don't have a strong feeling either way, but certainly if the committee wanted it covered, or if you think that the testimony supports having those pools of oil covered we will provide you language to do so. Number 070 CHAIRMAN ROKEBERG: Commissioner I, in my discussions with various members of the industry, I believe that would be the case, so I would ask that you provide us with some language and also for your information I have had some discussions, I believe with British Petroleum about defining a field (indisc. -- coughing) would that be part of the.... Number 079 COMMISSIONER SHIVELY: This is, part of, yeah, it's part of how you define a field and it has to do with us stating in the legislation that one of the triggering events would be a delineated field... CHAIRMAN ROKEBERG: Right. COMMISSIONER SHIVELY: ...and that probably does not allow us to deal with a separate pool of oil that's in a field that's produced. CHAIRMAN ROKEBERG: Right. COMMISSIONER SHIVELY: We have -- I can-- a suggested language. I can either have Mr. Boyd tell you what it is or we can provide it to your staff later, whatever your (indisc. -- paper shuffling) are. Number 090 CHAIRMAN ROKEBERG: If you wouldn't mind going ahead because I want to make sure everybody on the committee understands the concept of field. I think it's, from my position an example would be like Kaparuk as a unit, and when you have the Westsak(ph) formation has a different horizon and field even though it's in one unit then, I want to make sure everybody understands that concept. Mr. Boyd did you.... Number 099 MR. BOYD: Yes, Mr. Chairman, just to clarify, even at a lease level that we're talking about, -- same field as Commissioner Shively has said -- if you could imagine the lease, let's say it is a three by three mile lease, just extending to the center of the earth and everything that is contained in that lease then is considered to be a field and the way the bill is written, as Commissioner Shively has said, doesn't allow us to separate individual pools. In other words, if something were under production it would not allow us to give a royalty relief for something that was not under production. So the suggested change that I believe would cure that is on Page two of the bill. I'll begin with line 28. I want to be sure we are all on the same sheet music here, we're amending 3.05.180J. It's a new J begins on line 28 beginning with underlined bold text. "To allow for production from a delineated but not previously produced field," add the words pool or portion of a field or pool "that would not otherwise be economically feasible to prolong the economic life of an oil and gas field," and then insert that same language after the word field. So the words pool, or portion of a field or pool then would appear after the word field on lines 29 and 30 following the word field. Number 130 CHAIRMAN ROKEBERG: Do you have that in writing for us? Number 131 MR. BOYD: I have it in poor writing. Number 132 CHAIRMAN ROKEBERG: Okay, no problem. It will be reflected in the record, so we'll have that when we start drafting our committee substitute. As I mentioned, some members of the industry are going to make some recommendations on this line too obviously, and we can synthesize that particular language. Is there any questions of the committee on this particular area here? Excellent, moving on... Number 145 COMMISSIONER SHIVELY: In terms of my issues, that's it. We'd be glad to answer any further questions. Number 146 CHAIRMAN ROKEBERG: Mr. Boyd, is there anything -- as you return to the process -- is there anything you'd like to say about this particular bill? Number 148 MR. BOYD: No Mr. Chairman, but again, we're prepared to answer any specific questions the committee might have. Number 152 CHAIRMAN ROKEBERG: Okay, yeah. One thing that has come to light, and given the further studies, if the committee members would drop over to page three of the bill then we can, shall adopt regulations to (indisc.--paper shuffling) and also today there has been handed out to the committee members a copy of the Alaska Administrative Code, Section 11 AAC 83.185 Royalty Reduction. And, just prior to the meeting I gave the commissioner and the director copies of this and I asked them about this. One of my concerns right now is the legal effect of the deletion in the bill as proposed and the existing regulations, and also the fact that the bill calls for a (indisc.) part of industry of confidentiality in their application. And the regulations as I read them are really pretty fundamental in terms of just pointing out what information is required to be in the application, and also the public hearing process. So I guess my first question, which is kind of a legal question, is what is the effect of the deletion? Does that have any effect on the existing regulations, and the interplay between the two bills? And secondly, to follow up on that is the provisions for public notice in here because of confidentiality seem to be, they would seem to be needed to be deleted. Number 189 COMMISSIONER SHIVELY: Let me respond to that. Deleting the requirement for regulations does not prohibit the department from having regulations so I don't see a conflict there. In terms of the public notice for public meetings, I haven't really actually had much time to think about this. I would say if the information is confidential, the information would not be made available at a public hearing. The confidential information is covered by the requirements of state law and so if we had a public hearing we would have it only on those aspects of the application that the applicant agreed to have public. And the parts of my decision -- there will be parts of my decision, clearly, that are public, the best interest findings and things like that. But, so, I don't know that this is unworkable the way it's presently structured in regulation. Number 205 CHAIRMAN ROKEBERG: Well could we get some feedback from you... COMMISSIONER SHIVELY: We will get a legal opinion for you. COMMISSIONER ROKEBERG: ...how this all works. As well as, it might be, in addition under that section, and variously under existing regulations, I take due note that there is a sliding scale royalty at point 183. A definition there that may prove troublesome, or may be okay. You need to take a look at that to see how that may effect anything in the future. (indisc.) the provisions for confidentiality throughout the regulations and various other things. I think what you need to do is review the regs. and see how they mesh with the bill. Mr. Boyd. Number 220 MR. BOYD: Mr. Chairman, 11 AAC 83.183, the sliding scale royalty has been on the books for a long time. It is actually a method of bidding. It is something that is available now, it has been available for some time but it has been, if it has been used it has been very little used and I, it would be an up front sort of thing in the bidding process, it's brought in later, and it's a contractual obligation of the lease. Number 228 CHAIRMAN ROKEBERG: Rather than have the committee wade through the regs, why don't you guys do it and tell us what we need to do about it. MR. BOYD: Okay. CHAIRMAN ROKEBERG: Representative Ogan. Number 230 REPRESENTATIVE SCOTT OGAN: Thank you, Mr. Chairman. This method of bidding, there's four of them is that correct? MR. BOYD: I believe there's six. REPRESENTATIVE OGAN: Is it my understanding that every time a new lease sale comes up that DNR spends a fair amount of time deciding what method, looking at what method is best to use to bid? Number 239 MR. BOYD: Mr. Chairman, Representative Ogan, that is exactly right. The commissioner receives a partly confidential briefing at some point in the lease sale process, after the preliminary finding, and before the final finding is issued. The preliminary finding has a lot of issues, community impact, and things that we discuss. We discussed with the commissioner the issues of title and be sure the land is all clear and able to be sold, but during that briefing the commissioner is given information regarding what we perceive to be the economics of the area, the leaseability of the area, if you like. What we would suggest to the commissioner would be the proper terms and conditions and they would concern things like: what is the proper bidding method? And quite often, in the past, we've selected a royalty rate of 12.5 percent with a variable bonus. That has not been the case always in the past. Other leasing methods in different areas may have different applications. At the same time we pick a term of the lease. On the North Slope it's often ten years, in the Cook Inlet it is often seven years; and that just reflects the amount of time it takes to work, to mobilize in the limited drilling season and things like that. So, the commissioner considers all these things in each, as you say, at each lease sale those are then put into the final finding and those are the terms and conditions under which the leases are issued and they may vary from sale to sale. CHAIRMAN ROKEBERG: Representative Ogan. Number 262 REPRESENTATIVE OGAN: Thank you Mr. Chairman. Is it my understanding that generally they use the same method all the time. Number 265 MR. BOYD: Mr. Chairman, Representative Ogan, more recently that is the method that is used with, I'll say, a slight twist. The exploration incentive credit program, which is on the books, is another piece which is often added into the equation, leases that are being offered that are far from infrastructure or areas that we perceive to have relatively weak geology, we may offer an exploration incentive credit, and I think you know that gives the state the opportunity to offer a certain percentage of the well cost up to a certain limit. And this usually provides that the lessee drill in a certain period of time. But, in the near past, the 12.5 percent with sixty and two-thirds in some cases, or a mixture of those, the terms of the lease sale need not be the same for every lease and in some cases we've had leases that carry a 12.5 percent royalty with a variable bonus, and some that had a sixty and two-thirds royalty with a variable bonus. And that has been deemed by our economists and our staff to be the method that was most likely to be in the state's best interest. Number 290 CHAIRMAN ROKEBERG: If you go back to the existing regulations, section four, there's contained a detailed statement covering the entire life of the lease showing all expenses and costs of operating the lease including all the royalties and over-riding royalties, and all income from all produced minerals from the lease. That's section four of 11.AAC.83.185 for the record. Could you, one of the concerns that's come to light is the information we got in (indisc.) basis from Marathon Oil about their North Trading Bay application which was turned down as every application in the history of the state for this provision has been turned down. I have finally been able to verify there never has been a grant of a royalty reduction to the to my knowledge. Is that correct? Number 304 MR. BOYD: (indisc.) my recollection that's true but I believe there have been, I'm sorry, there have been three applications to my knowledge: the Trading Bay, there was one from Texaco, and then there was then Conoco Oxy. But, Conoco Oxy, which went through, as you know, litigation and negotiation finally settled for a past value but there was a royalty reduction granted to Occidental from twenty percent to twelve and a half percent but only to Occidental and only on some leases. I believe it was six or seven leases. I could get those numbers. Number 314 CHAIRMAN ROKEBERG: I sit corrected. I'm glad, we've been trying to get at that... MR. BOYD: Yes. CHAIRMAN ROKEBERG: ...actual fact. Number 316 MR. BOYD: That's quite recent, that decision was in 1993, I believe, late 1993. I can get you some details on that, Representative. Number 318 CHAIRMAN ROKEBERG: We'll go back to my question. What happened with Marathon was they had purchased a lease and platform in the inlet and which had gone through two sets of ownership apparently over a period years. Also, when they purchased the property they really didn't have all the historic operating data that went with it, and so when they applied for reduction under J, and basically, it was refused in the process because the then director asked them to provide this historic data which they didn't have, so therefore they couldn't go forward with their application for reduction. And what's occurred with that particular formation, the North Trading Bay one, as I understand it, it is that well, the oil production on that well field was shut in, and because of the geology there will never be able to be reopened. Therefore, the, what seems to me an obstacle, was put up by the bureaucracy, overcame the intent of this statute, and that particular field is probably blocked forever because of that. Therefore, I'd appreciate it if we could look at the regulations, or in the statute and make some provision that would allow for an instance like that whereas if the data was not readily available to the applicant, particularly for an older field, that they wouldn't be necessarily penalized, because it seems to me that even the lay person could understand the economics of the equation of an older field for the granting of a reduction. I don't think you necessarily have to go to all the historic economic investment there to be able to view that instant situation, to be able to go forward with the proper decision, whether to grant a reduction or not because the life of the field is very finite. Mr. Commissioner. Number 352 COMMISSIONER SHIVELY: Yeah, that's why we took out the language that talked about the rate of return with respect to the lessees' total investment in the field. Under the old law, I think you were required to get that kind of information in order to make the finding that was required on the rate of return. That's precisely because of that kind of problem, and the problems we talked about before about what happens when you get close to shut-in or abandonment why you don't take in the total rate of return on the field. So, I think that that change does, would allow us to go back and change the regulations, but I think under the current law we had no choice. Number 362 CHAIRMAN ROKEBERG: Right. Well, I think we need to.... COMMISSIONER SHIVELY: We would make such a choice. CHAIRMAN ROKEBERG: How do you stipulate an accommodation for that instance particularly as it relates to existing producing fields or older fields? How are we going to (indisc.) for that. I think that's, it's more than unfortunate. You have all the sum costs in an actual offshore platform and they may, as I understand it, produce some gas from there but their not, they will probably never be able to produce any more oil. And that's because of political decision. I don't know. I'm not going to editorialize, excuse me. Number 371 COMMISSIONER SHIVELY: It may or may not. I'm not going to try to second guess my predecessors but, but I think that the law was somewhat constraining in that regard as it was then written and that's one of the reasons were taking that section out, because it provides just the kind of restraint that we were talking about. Number 376 CHAIRMAN ROKEBERG: I can appreciate that. I spent most of this weekend trying to come up with a definition of reasonable rate of return, and ultimately, after much reaction on the part of several people in the industry, I may have to scrap the whole idea because it may be the wrong approach even, and that may be... I mean your argument about why you -- if you remove that from the statute -- may hold more water and we can talk about that later. At any rate, so therefore, that was a point I wanted to make on these regulations. And also under four, right now if that regulation, that line wasn't changed it may create a, you know, major burden on the part of an applicant depending in particular old fields, but I don't know what other ramifications there are. How would you perceive the process? I mean, as I mentioned, you would have to have all the costs.... Number 394 COMMISSIONER SHIVELY: Let me go through what I see, you know, the process being, because there are really three major events that happen. The first thing is that the applicant would have to come in and I would have to find that there is a delineated field, or if we make the change we talked about earlier, a pool. That is the first thing that I have to find, and if that doesn't exist then the process stops. If we determine that, then we have to determine whether or not a royalty reduction would change the economics so that a marginal field could start development or an old field could keep going. In that case, I have to look at all the economic data that the applicant wants to make available to the department, some of which may be public and some of which may be confidential. So, and then we will determine whether or not the royalty reduction we think affects the economics, so that a field can go forward. Once we've made that decision we still have to make a decision of whether or not, even if we believe that the economics are improved, that it's in the state's best interest to go forward and give them that reduction. So there are really three steps to the process. Number 412 CHAIRMEN ROKEBERG: Very Good. Because one of my concerns is that it quite clearly states that the application will include a statement covering the entire life of the lease showing all expenses and costs of operating the lease. I mean, that's a very broad requirement. And let me, let me go on to say that for the information of the committee members what I'm concerned about here is if after the department reviews this, the bill and existing regulations to find out the relationship, that, rather than to have, ask the department to go back and rewrite the regulations, I believe it's going to be my recommendation that these regs, which are not real long, be revised to meet this new bill and then put in the statute so then they don't have to go through the regulatory process. So I'm going to ask for a recommendation from the division on that, and that way, that does a couple things. It speeds up the whole process. We don't have to wait six months for them to write one page of regulations, if you will, and go through the approval process and the approval by the Lieutenant Governor and various other things. I mean, that's what I'm thinking of. And in doing so, when we do that, then these, then these standards might take on a much higher impact. So, if we do it we need to be careful about what we are putting in there. Mr. Commissioner. Number 435 COMMISSIONER SHIVELY: Mr. Chairman. I do not find section four to be particularly constraining even with the change. I mean, this is the kind of information we will need, they'll have to estimate the life; they'll have to estimate their expenses, their costs, including the royalties overriding currents. All that information is going to have to be in the application. So I don't, although it's sort of written a little bit to take care of the existing law, which is fields that are about to be shut-in or abandoned fields, I think, I think it's workable, but we will go back and look at them. Number 442 CHAIRMAN ROKEBERG: Well how about -- but you would have to revise, I would think, based on a new field. In other words, their performance or other models they may have to demonstrate to you. Number 445 COMMISSIONER SHIVELY: It says a detailed statement can tell you, cover the entire life of a lease showing all expenses. Well, if the lease is just starting it's their projected expenses. CHAIRMAN ROKEBERG: Right. COMMISSIONER SHIVELY: So, I, I don't think that that language is (indisc.--papers shuffling). Number 452 CHAIRMAN ROKEBERG: Very good. So, if you could give us, get back to us on that section. There is one think I would like to clear up right now. It's a little bit of a bookkeeping thing. It goes down to the third-party contractor. I'm trying to see where that is. COMMISSIONER SHIVELY: Oh yeah. Number 464 CHAIRMAN ROKEBERG: On line, page three, line eight I believe. The condition of evaluating application and data, the commissioner may require lessee to pay the cost of contractors selected by the commissioner to assist in the evaluation. I've had some conversations with the various members of industry and there is, has been raised some concerns about the fact that a contractor may be selected by the commissioner's office, but they may have to have had some bad experience, or the commissioner applicant does not like the contractor selected by the commissioner, and I, there has been a request for him, well, here's some tests for the future about mutual agreement or something like that. You care to comment on this process? Number 465 COMMISSIONER SHIVELY: I would. It think it's important that we understand what we're doing here. Ordinarily, if we have the staff capacity, the application comes into the commissioner, goes to the division of oil and gas and it will be the staff of the division of oil and gas that will make the determination. The industry, whether they like our staff or don't like our staff, really doesn't have the ability to choose which of our staff members review that. In the case where we feel we cannot cover the, take care of the application internally we would say that we wanted to use an independent contractor and that the applicant would pay for it. I, believe the independent contractor has responsibility to the state really. I mean, that's who they are working for. They're make assessment for the state, not for the industry, as to whether or not this proposal is accurate. We have to control that decision. So, the most that I would be willing to look at for a change there would be a one-time veto of one contractor. So, if they, if we named a contractor and they said no, we don't want that, sort of like the lawyers and judges where, where you get sort of an opportunity to get one judge in. I mean, I, we haven't really made a position on that internally. I haven't discussed that, but that's the furthest I would go. But I, we are not prepared to sit and negotiate with the industry over who should review an application that has to be reviewed for the public interest. Number 485 CHAIRMAN ROKEBERG: Well, could, could you give that some thought and get back with a recommendation to the committee on that so we can, you know, perhaps compromise and take your method and then make a... Mr. Boyd. Number 490 MR. BOYD: Mr. Chairman, I would only add to Commissioner Shively the testimony that generally speaking, I believe the, the contractor would be used in a purely technical sense. We would be feeding him the company numbers and it would be the hard grinding of numbers. The contractor wouldn't be making policy. The numbers we get back I think would be a matter of equations and, and facts, and not of speculations so much. I mean, the speculation, if you want to use that word, is in deciding whether when the numbers come back, its in the interest of the state to grant the reduction. The contractor is not in the position to make that decision. Number 500 CHAIRMAN ROKEBERG: Well, I think it, as I took it, was that the confidential nature of the data was sensitive and they were concerned about who was looking at it. I mean, that's kind of common sense. I think that was a concern, really. Not so much the competence or something like that, or perhaps a bad experience with them and yeah, there is multiple reasons. Those requests are coming so if we can kind of nip it in the bud. REPRESENTATIVE FINKELSTEIN: Mr. Chairman. CHAIRMAN ROKEBERG: Mr. Finkelstein. Number 505 REPRESENTATIVE FINKELSTEIN: Just while we're on that subject, I, you know, while you're thinking about it, I think it might be worth reflecting on how we do this in the rest of government. Is there an example anywhere in government where we allowed any regulated industry to have some say under both employees and the contractors that state government chooses to make its decisions because its of, well, I could understand, you know, the reasons some might want to have something like this in there. I think it could be a horrible precedent. I've certainly never heard a place in government where we let industry veto, even once, the choices the state government makes as far as its employees and its contractors. Maybe there is some place in government I'm missing, but I, I certainly haven't seen it before. Number 515 COMMISSIONER SHIVELY: Well, the only, certainly the only place I know of, and I haven't done any research on this, is the judicial system, which is fortunately or unfortunately, part of government and they do it all the time. Number 517 REPRESENTATIVE FINKELSTEIN: In a court proceeding? Jury selection. Number 519 CHAIRMAN SHIVELY: Also judge selection. I mean, you're allowed to kick out a judge, and either side can do; both sides can do it. Number 529 REPRESENTATIVE FINKELSTEIN: Right. There's two parties. Here there's one party. Okay, in fact, it turns out in this case its an unappealable decision before a regulatory agency. There is no other party. You are both parties. You're making a decision and you're representing the public interest, so. Number 525 CHAIRMAN ROKEBERG: The, I would like to just open up discussions on the confidentiality and the whole review system. I know that Mr. David Johnston is going to be testifying this morning from the Alaska Oil and Gas Conservation Commission, and I'd like, before he testifies, I'd like to have your input on the idea, and let me try to articulate what the chair's thinking is right now. One of the concerns under the bill is that the commissioner will have almost untrammeled discretion in making the grant. Therefore, it's I think, in the best interest of the state that the, we expand the overview and oversight of the decision-making process, particularly in order to reassure the public that the decision made by the commission is in, is in keeping with his charge. And in certain ways to do that is to have more people involved in the decision- making process. However, because of the confidentiality nature here, that review has to be limited somehow to an in camera or confidential hearing basis. As a result, having talked to a number of people, and I've asked Mr. Johnston to testify this morning, it's my thought that I'd like your views on bringing the conservation commission into the loop as either a, the group from which an appeal could be made by the applicant and/or a competitor or somebody else with stipulated standing to make a complaint and then have the commission act as the oversight agency and the appeal board there. Or, in addition, or, and/or have the commission act as either the final arbiter whereas say you've made the best interest finding and recommended that they, you know, you grant the application and perhaps send it to the commission, have them review it to make sure it's, in their opinion, a proper decision and accept, reject or send it back for modifications. In other words, it's my intention to try to open up that area of oversight then conflicting the commission, in my opinion, I think is important because they're normally, they're, the nature of the commission will find out about that later is such as they are used to working with this type of information. They are also used to working on a confidential nature because their primary charge is the unitization and the conservation of, of the hydrocarbons that are produced in the state, and there is, I take it, there is, I believe there a (indisc.) engineer and geologist public memo on the (indisc.). In addition, there are people that are appointed for six years and they can only be removed for cause, so there's a political installation (indisc.). We already have them there. They, you know, you don't have to create this thing. And there is the royalty board too, which is a different, so. I'd like to have your comments on pursuing that idea at this stage and then in a few minutes we'll take some comments from Mr. Johnston and talk about this. Number 571 COMMISSIONER SHIVELY: Yeah, well, I mean, you know, if you feel you need a review process, I mean, that's a decision obviously for the committee to make. We, we have said that we do not think so, that any review process increases as a minimum the time, and probably the cost of, of this, and I, I guess in terms of who you use, AOGCC is certainly a candidate. They certainly can determine and know how to determine what a field is, a delineated field or what a pool is. I don't, they certainly have the expertise for that. I do not believe that they have the expertise on staff to make the economic determination, which is, I think, critical to the whole decision here, and that in terms of reviewing the best interest findings probably they could do that because the best interest findings are really a statement of, of my beliefs or any other commissioner's beliefs as to why they should take place. So, I think the question for any review panel is how they would be prepared to deal with the economics and what would be the cost to government, and then whether or not whether or, I think another consideration for you and for industry is whether or not you want to put any constraints in term of time limits for review because if you're going to have a process where the commissioner or the royalty board can keep bouncing things back and forth, I mean, we've seen government operate that way and I, it ends up I think with potentially a fair amount of waste for both government and industry. Number 571 CHAIRMAN ROKEBERG: I certainly agree with you on the time frame issue there. Representative Brice. Number 592 REPRESENTATIVE BRICE: Just for clarification, Mr. Chair, of what you're trying to get at. You're looking at overview, or having somebody look over the commissioner's shoulder to, number one, make sure he doesn't give away the barn, or/and to make sure that industry has an appeal process outside of the commissioner. Is that right? CHAIRMAN ROKEBERG: That's essentially it. REPRESENTATIVE BRICE: Okay, okay. So, for those two times. Okay. Number 600 CHAIRMAN ROKEBERG: Matter of fact is if I could read, I received a letter last Friday from an individual's attorney in Anchorage. It's a pretty good letter. In it he indicates that the one thing we need to be careful, and this is kind of more, if I could be permitted to read a sentence here. It says, "A governor's bill would substitute for a free market for us as an entirely private process open to outright skullduggery to the subtleties of political favoritism and influence peddling, or just plain stupid decision making." I mean how does he really feel about this? Yeah, how does he really feel about it? REPRESENTATIVE BRICE: Well, Mr. Chair, what I don't understand then, I guess then, is why the concern is for that, or for royalty reduction, which has probably a limited, of limited actual benefit to the state, particularly when we're looking at when the attorney general's office has their sole ability to go in and close out on oil settlements, you know, which have, then you know, billions and billions of dollars to the state. It might be something to consider having the attorney general provide the overview of the, of the commissioner in these times. CHAIRMAN ROKEBERG: No. Number 620 REPRESENTATIVE OGAN: Mr. Chairman, on that point. CHAIRMAN ROKEBERG: Representative Ogan. REPRESENTATIVE OGAN: The attorney general has, you know, has gone in and closed out a lot disputed cases after the fact and I think with a little bit of foresight having the advantage of looking in the past with 20-20 vision, if things were more clearly set out and maybe some safeguards were put in place in the first place there wouldn't have been all these, this litigation, and I think it's, personally, I, I kind of agree with a little bit of extra oversight, not, with all due respects to the commissioner, I think our whole system of government is, is set up on, on the idea of checks and balances and I think it would certainly behove us to... We're talking about a serious amount of money here and, and a really long impact on, on the state. My concerns for this are the fact that, you know, the fact that we've spent so much time in court and so much money resolving disputes in the past that clearly there's areas for dispute. Number two is that assuming everyone is playing by the rules nobody knows how much oil is underneath the ground and, and if there is, you know, it's an educated guess at best, and plus technology has continued to increase and as the fields lose more oil, assuming that they may, I think it would be good to have some, some extra oversight there and, and, and some safeguards for those fields that do produce more than they originally are expected. Number 635 REPRESENTATIVE BRICE: Mr. Chair, I think that's why we want to delineate between review to make, oversight of the commissioner, to make sure that he doesn't give the farm away to begin with. And the process by which somebody can appeal the decision of, because they are wholly two different things. I mean, you know, there's various different appeal processes that we have, have, I mean they are only limited by your imagination for the most part as far as relevant. I guess I'm concerned that if there is a concern that the commissioner is going to give away all our royalty then to, in the, in the need to make sure that it's done in a timely fashion, that it's done, you know, in an appropriate fashion, that somebody is, and that's why I keep coming back to the AG, you know, I think I see that's a role that the attorney general could more than adequately fulfill versus, you know, throwing it to another long process of through the conservation commission. And, but you know, in times of dispute and the need for an appeal process, you know, that's something else that, you know, we can discuss. Number 660 CHAIRMAN ROKEBERG: Right. The, one point, early on I think last week I think, I discussed with the commissioner -- we can get his comments on it -- I also though of, I call it the triad of having the commissioner of revenue the AG and the commissioner of natural resources do that, but then I think there's some structural problems, I mean various problems and perhaps commissioner Shively would like to comment on what his perception there is. Number 666 COMMISSIONER SHIVELY: Well, I, I, again it depends on what kind of process you want. If you want a review by two other officials that obviously have some background in, in oil and gas development and leasing, those would be the two, or at least the economics of it, would be the two obvious ones, and, and if that gives people extra comfort I think it could work, but the problem I have with the review process is that once you open it up, I mean, if, you either have one or you don't, and so if, if you have one then, you know, if, let's say its Exxon that came in and asked for the royalty reduction, yes, they would get to appeal if they thought I was unfair. If BP thought they were getting too good a deal and had a competitive problem, they'd take it up. If Trustees for Alaska just doesn't like the whole development they get involved. What happens, my experience, and this is one of the things that drives me nuts about the judicial system is whenever you ask a judge to solve a problem he thinks he has, he or she thinks she has to change something, and so you're asking, whenever you're asking a body to review you're really encouraging them to make changes. So, I, I mean you're going to have to make that decision. It's a tough choice. One is a more open process, more comfort, and the other is getting a decision and getting on with it. We obviously prefer the latter, but I certainly understand the concerns of you and others have raised about, about a process that provides more review. It's just, it's just not an easy, easy decision to make either way. There are dangers on both sides. Number 685 CHAIRMAN ROKEBERG: So, you're suggesting it's something we need to struggle with ourselves? Number 686 COMMISSIONER SHIVELY: Well, we're certainly pleased to help. We, of course, have our position, so... Number 688 CHAIRMAN ROKEBERG: If I might, if the committee would indulge my, me a (indisc.) that in my long years of being in business, particularly the real estate business, I found that whenever an attorney got involved in the deal they'd screw it up. I bring in the AG and stuff like that kind of worries me. Number 692 REPRESENTATIVE BRICE: I think the AG though has a lot of background historically, in oil and gas disputes and is considered, I mean, the state's primary negotiator in terms of those disputes, and it's just a logical process. CHAIRMAN ROKEBERG: I had a similar idea, Representative... REPRESENTATIVE BRICE: Yeah, the triad thing, like you're talking about, could be something with, that could be worked on. Number 696 CHAIRMAN ROKEBERG: The problem there, as I see it, however, is all three of these people work for the same boss, and therefore, you know, what, really what point, what level of review are you going to get. I mean, once the, I would say the commissioner of Natural Resources make a decision (indisc.) it's still a possibility. I think there's some other problems with it. I think we need to discuss it when we are doing a markup later. TAPE 95-9, SIDE B Number 000 REPRESENTATIVE G. DAVIS: We were talking about something different in back tax litigation compared to understanding the oil reservoirs and things like, you know, that geological nature, and I think there was also a lot of, of contracting and consultation on the AGs part, which, again, adds to expense and time. So, I don't know, maybe the commissioner can, can, you know, talk about that a little bit. I don't see the AG, I think, I think you're laying out a lot more the confidentiality aspect out of a lot more people's desks going through the Ags Office than, than someone else specifically knowledgeable about the technical nature of, of the situation. Number 019 COMMISSIONER SHIVELY: Mr. Chairman, Representative Davis. I think you've hit on the problem. There really isn't anyone else in government with the full expertise to make this decision. There are people that understand oil and gas pools and fields, and clearly, the AOGCC does that. Really, in terms of the economics of the field, certainly the division, the department of natural resources has it. I think the department of revenue may have it to a lesser extent because of their tax responsibilities. The Ags office has it in people, but they have it in people largely that would be advising us on whether or not we should go forward with making a positive recommendation on the application. So, if you want to buy the same kind of expertise to make this decision that we're going to use initially, it's going, somebody is going to have to go out and spend some extra money to do it, and whether that's the applicant, the appellee or the extra government agency I guess is an issue that you would have to address. Number 043 CHAIRMAN ROKEBERG: Look, as long as we're on that subject, I think that, well, let's, let's haul about here. Let me do some little housekeeping here. I'd like the record to show that Representative Finkelstein arrived at 10:10 and Representative Williams at 10:15. I think I could, oh... Representative Ogan, he showed up too. REPRESENTATIVE OGAN: I'm not sure. I thought we might have had some (indisc.). CHAIRMAN ROKEBERG: I thought you were already been on the roll though (indisc.). REPRESENTATIVE OGAN: It's my job as vice chairman to keep him in line. CHAIRMAN ROKEBERG: That's correct. REPRESENTATIVE OGAN: Tough job, but somebody's got to do it. Number 060 CHAIRMAN ROKEBERG: The, there's a few things I'd like to talk about today. They have, they revolve around the confidentiality issue and then there's a number of other things, but I think I'd like to take, if you don't mind, testimony from Mr. Johnston because we're on this topic and if you could just, and if you could just hang with us or do you have any other scheduling problem? Number 070 COMMISSIONER SHIVELY: Mr. Chairman, I have to be in the Governor's Office for a bit. Mr. Boyd will stay here. He's fully capable of staying and I will try to come back as soon as I am done upstairs. CHAIRMAN ROKEBERG: Good. And there's, actually a number of things I want to discuss, but they're almost more in the way of queries also that I would like to get some additional information too, so that would be certainly okay. Mr., Representative Ogan. REPRESENTATIVE OGAN: Mr. Chairman. Commissioner Shively, would you have time to answer one question before you go? COMMISSIONER SHIVELY: I certainly will. Number 077 REPRESENTATIVE OGAN: Would you define what would be in the best interest of the state? CHAIRMAN ROKEBERG: You don't have time for the answer. Do you have time? Would you like to think about that and come back? Number 087 COMMISSIONER SHIVELY: Representative Ogan. Actually, sort of term of art of virtually everything the department does for major decisions and it's something, to be perfectly frank, I'm still trying to get comfortable with. If we do a timber sale, or oil and gas lease sale (indisc. - someone coughing) assets, we, and I believe it's sort of a constitutional requirement. There's a, if I recollect correctly, that when we do these things that it be in the best interest of the state. When you make a best interest finding you're probably going to take a number of things into account. You're going to take into account whether or not the state is receiving any revenue. You may take into account environmental impact. You're going to take into account whether or not you're creating jobs. You're going to take into account probably whether local governments feel that there is some advantage here. You're going to take into account whether in an oil and gas field where they're keeping that additional production on assist both in keeping production facilities going that might also otherwise be shut down or may have an impact on the tariff on the pipeline. So, there are a whole list of issues that one looks at to see whether or not on the whole this is, this is, it's better for the state to do this than not to do it. But, there's not a formula. REPRESENTATIVE OGAN: Thank you. CHAIRMAN ROKEBERG: Very good. REPRESENTATIVE FINKELSTEIN: Mr. Chairman. CHAIRMAN ROKEBERG: Representative Finkelstein. Number 112 REPRESENTATIVE FINKELSTEIN: I had questions I can hold off until later, but they are to follow up on the discussion we had earlier about the existing royalty reduction provisions and the attempts to use them in the past. CHAIRMAN ROKEBERG: Right. REPRESENTATIVE FINKELSTEIN: So I could ask them now or ask them later, whatever is better for you. Number 115 CHAIRMAN ROKEBERG: Why don't we -- I indicated to Mr. Johnston that we would be taking his testimony around 11 o'clock, so I'd like to do that and then we can go back if that's okay. Thank you, commissioner. We hope you can get back and join us. REPRESENTATIVE FINKELSTEIN: Thank you, Mr. Chairman. Number 124 CHAIRMAN ROKEBERG: You're leaving us in good hands. Mr. Johnston, are you there? DAVID JOHNSTON: Yes, I am. CHAIRMAN ROKEBERG: Thank you for your patience and I really appreciate your coming out and testifying today, and hopefully, you have heard some of the discussions leading up to this right now and given that, if you'd like to go ahead and make some comments about it we'd appreciate your input. MR. JOHNSTON: Okay. (Indisc.) to Representative Rokeberg and members of the House Oil and Gas Committee. For the record my name is David Johnston, Chairman of the Alaska Oil and Gas Conservation Commission. I appreciate this opportunity to comment on House Bill 207. Just a little bit of background on the Oil and Gas Conservation Commission. We are an intended quasi-judicial agency of the state. We primarily serve as the chief regulator of Alaska's oil and gas industry. The commission acts to ensure that maximum ultimate recovery is obtained; to prevent the physical waste to crude oil and natural gas; and to protect the correlative rights of persons owning oil and gas interests and land subject to Alaska's police powers. The commission is headed by three commissioners appointed by the Governor and confirmed by the legislature. Each commissioner serves a six-year term. The terms are staggered. By statute, one commissioner must be a registered engineer, another must be a petroleum geologist and the third need not have any particular expertise. I want to commend Governor Knowles for his leadership in encouraging oil and gas development in the state, providing the means to reduce royalties on marginal accumulation, sponsor investment and jobs and recovery of oil and gas that may otherwise be lost to the state. As with any bill, some fine tuning of this legislation may be appropriate, however. For example, I suggest that the committee consider whether to allow royalty reductions on leases that are compulsory unitized by the commission under AS 31.05.10. This can be (indisc. - background noise) by asserting this provision in line three on page three. What the, line three essentially reduces the royalty on individual leases, or leases unitized as described in T of this section, but leaves out the compulsory unitization process that we engaged in on AS 31.05.10. I believe it would be appropriate to include it in the compulsory unitized leases as well. Another change, and there was some mention of this earlier, but a change that may be appropriate is to require the lessee to hire a third party independent contractor acceptable to the commission, the commissioner to assist in the evaluation. This change, of course, would apply to eight, nine and ten on page three. As now written, the commissioner would hire the contractor and the lessee would pay the cost. My suggestion would take government out of the hiring circle, eliminate the burdens of R&E process and allow industry to directly negotiate the best contract. (Indisc.) the commissioner to condition a royalty reduction with the means of increasing or otherwise modifying the state's royalty share to certain factors such as oil, excuse me, such as the price of oil and gas and change, the price of oil and gas and change. It may be appropriate to time this prevention so that arbitrary revisions do not occur with each fluctuation in oil price. For this incentive program to work industry must have some assurance that a royalty reduction granted today will not be arbitrarily altered by a future commissioner solely because the price of oil may have changed by a few cents. The commission is also aware of the concerns expressed by some about putting such power in the hands of one person, especially, especially when the royalty reduction decision is not appealable. Should the legislature identify a role for the commissioner addressing these concerns we standing willing and able to offer our services as an independent quasi-judicial agency (Indisc.). This concludes my direct testimony and I would be happy to answer any questions (Indisc. - coughing). Number 209 CHAIRMAN ROKEBERG: Well, thank you, Mr. Johnson. How you, could you explain to me how you conceive the process? I think there's two different ways we can look at it right now. One where you would be like a standby oversight in case there was an appeal requested or if you would be specifically in the loop as a, as oversight. There's two different ways to, to use your, your commission here. I'd like to have your viewpoint on that. Number 217 MR. JOHNSTON: Well, as I understood the conversation, it appears that there is concern that, that this process being broadened and I believe that the Oil and Gas Commission can be considered as an appropriate agency to look to our board to provide this wall. I think it would probably be only appropriate though for us to either confirm or deny the position of the commissioner as having a reasonable basis and that the process was all above board. I don't think it would necessarily be a problem though for the commission to substitute its judgement for that of the commissioner of natural resources and charge them whether a royalty reduction should be applied as the extent of their reduction. Number 230 CHAIRMAN ROKEBERG: I agree. I think that's the way to go myself. And that's, as I brought up earlier about plain stupid decision- makings and other skullduggery, that, that's where you bring the light of day. I mean, you know, I think I, I'm comfortable with that type of approach. Could you talk about the time frames involved in this or how you see that working? Number 239 MR. JOHNSTON: I would just like to mention that as well under our statutory authorities the commission is required to render a decision within 30 days after a hearing. So, presumably if, if there was some entity out there that wanted to have our review we would go forward with a hearing. Once that hearing was held then within 30 days we would issue a decision. Number 248 CHAIRMAN ROKEBERG: Good. And, I'm not sure. Did you answer my question? I was trying to make some notes here about what your preference in the process just as, just an over... just as the appeal, or just... Number 254 MR. JOHNSTON: Yeah, I'm not sure. I'm not following that. Basically, you know, I see us working I guess one or two ways depending on how the legislature would like to structure it. One, we could only be brought into the picture if there was an actual appeal or, or somebody protesting the decision, or two, we could look at all royalty reductions decisions that are rendered by the commissioner and just, you know, vote up and down, or vote the proposal up and down after a review, after a public review, to assure that the process was aboveboard. Number 263 CHAIRMAN ROKEBERG: How about modifying it and sending it back if you... Number 265 MR. JOHNSTON: Yeah, I think that would, could be something that could be done. It could be sent back to the commissioner for further work... CHAIRMAN ROKEBERG: Right. MR. JOHNSTON: ...if we felt that, I don't necessarily know if the commission themselves would want to get into the modification process, but we could express our concerns and request that the commissioner direct some attention to that. CHAIRMAN ROKEBERG: Representative Brice has a question for you. Number 270 REPRESENTATIVE BRICE: Could you please clarify what you had just said? You had just said something that, these decisions would be under public review? Or did you mean commission review? Number 274 MR. JOHNSTON: Well, what I meant is we have a public process. We would put out a notice and then convene a hearing. We would ask people to come before. We would swear those people to testimony, and we would review the process that was engaged, you know, that the commissioner engaged in, in granting the royalty reductions. That is a, a public process that we would conduct. In terms of protecting the confidentiality of data we also routinely deal with that and in those cases we would close the hearing so the people that have a right to hear that public, or confidential data. REPRESENTATIVE BRICE: Okay, okay. Number 286 CHAIRMAN ROKEBERG: Well, that was my next question is how you handle that confidential data and how that fits into the whole process? And I think you've pretty much covered that. Number 290 MR. JOHNSTON: We routinely deal with confidential data all the time, and we have processes to, to address those concerns. Number 293 CHAIRMAN ROKEBERG: Very good. So, you guys are willing to take this on. Will it create a burden for your commission? Or, is it something you think you can handle in your normal workload? Number 298 MR. JOHNSTON: Well, I, I think again it would depend on the nature of how the legislature structured the review process. Commissioner Shively was correct when he indicated that we do really have a lot of expertise in the commission when it comes to economic analysis and evaluation. And if that was a desire of the legislature to look at that type of, to that level of detail then basically, we would have to request additional money for a, for an office, for example. On the other hand, you know, judges make decisions all the time based upon the reasonableness of the decision and not necessarily a detailed analysis, and I would think that that is probably the approach that we would desire to take. We would just review it to make sure that there was, that the Commissioner of Natural Resources acted properly, that there was no shady dealings involved in that thing and provide the assurances to the, to the residents of the state that this process was done all aboveboard. CHAIRMAN ROKEBERG: Representative Brice. Number 314 REPRESENTATIVE BRICE: Maybe it's not necessarily a question for you, but a comment. Okay, then after the commission, conservation commission makes this determination that the commissioner, you know, they confirmed that the commissioner, commissioner's logic was, was appropriate and everything else, and accepts it, and then somebody comes in an says, "We want to appeal that decision.". Where would that appeal go to, or would that decision be appealable? Number 328 CHAIRMAN ROKEBERG: Well, I think that we're going to request of the department to have their legal, legal opinion... REPRESENTATIVE BRICE: Okay. CHAIRMAN ROKEBERG: ...legal opinion as it relates to all these, all these matters of appealability, the outside fair party due process... REPRESENTATIVE BRICE: Yeah. CHAIRMAN ROKEBERG: ...from the AGs office through the commissioner of natural resources here a full legal analysis of these ramifications to go with this bill, or make any changes, and I'd like to get that as soon as we possibly can because I think in our last hearing, on last Thursday, there was, we brought up those questions and frankly, the answers are not, weren't really satisfactory, you know, to me, and I'm sure that there's other questions of the members of the committee in that regard, and so, we really should get that cleared up so we under... there's full understanding in this committee process at this time of what, what, what happens there. It's entirely conceivable that we may want to recommend that the standing for anybody to appeal that decision be extremely limited. Let's say for example, to the applicant himself, and/or a let's say competitor or somebody with a clear economic interest in that particular field, or you know, for example, you know, there's an adjacent field or a sort of production field (indisc.) that area that clearly that other company may have a compelling interest or reason to make a complaint, but a minimize outside type complaining about it. I mean, there's, that's something we need to talk about. In order to have that conversation a legal opinion (indisc.). Representative Finkelstein. Number 356 REPRESENTATIVE FINKELSTEIN: Thank you, Mr. Chairman. Though we also, we want to have some ability to deal with the kind of things you deal with in that letter of mistakes and, you know, deals that are improper. There has to be some way for someone other than a competitor to, or a actual company to review the deal because if it's just the companies involved they have no incentive to ask for any review. (Indisc.) Number 362 CHAIRMAN ROKEBERG: Well, that's why we're talking to the, the Conservation Commission here for that very purpose and as I understand it, at this stage, there is nothing that would bar a citizen of the state of Alaska to make a challenge based on the constitution to something like this. In other words, if they thought the commissioner was giving away the store, under our constitution it's, I think, fair enough they may all be able to bring a cause of action against it. So, there may be nothing we can do about that, so, but we need to understand that going in here what,... REPRESENTATIVE BRICE: That's right. CHAIRMAN ROKEBERG: ...what happens. Representative Finkelstein. Number 371 REPRESENTATIVE FINKELSTEIN: Thank you, Chair. Just a question for the commission. The, you mentioned that the, at this time, you don't have much experience in the world of pricing and those sort of things. Does the commission have any authority or any involvement now in anything having to do with royalties, taxes, or any of these other pricing mechanisms? Number 378 MR. JOHNSTON: What we focus on is the actual production of the resource. We do not enter into discussions having to do with royalty or taxation. REPRESENTATIVE FINKELSTEIN: Okay. Thank you, Mr. Chair. Number 380 CHAIRMAN ROKEBERG: Okay, one thing, Mr. Johnston, one thing before I forget it. If we are, if we're going to put you into the statute on oversight basis, could you, could you make a, submit a memo to us as soon as possible about any statutory changes, or scope, or enabling statutes that may, that you see may be necessary to get you in the loop? Number 389 MR. JOHNSTON: I would be very pleased to. CHAIRMAN ROKEBERG: Okay. Representative Davis. Number 390 REPRESENTATIVE G. DAVIS: Thank you, Mr. Chairman. So, the question here isn't, it seems to me there's two phases in this thing. There's the, there's the findings that are going to determine whether an adjustment should be made, and then, there's the size of the adjustment. So there's two things. There's the, the technical geological aspect and there's the economic aspect. So, and where is our concern? Is it in both or is it in one because it seems like the decision on the feasibility of the request is going to be made in the findings aspect, and then, then it says, yes, there is some grounds for some review here. So then, the commissioner drops it off -- well, that would be in your lap too -- even that decision would involved in the findings, so it seems like, like that's one phase of the deal. Then the other phase is determining the size of the adjustment. If... Number 405 MR. BOYD: Mr. Chairman, Representative Davis. That's, it's exactly right and that also falls within our shop because we have the geologists and the geophysicists because, as you recall from the bill, it's on delineated fields and you can say that in a particular field you do things on a lease by lease basis, and that's a part of the decision-making process, as you say, to decide not only how much is the reduction but on which leases it might apply. And that's part of the finding process and that goes back to the economics; an economic decision. Number 413 REPRESENTATIVE G. DAVIS: Well, Mr. Chairman, if I might continue. The division of oil, those people on the line... CHAIRMAN ROKEBERG: Conservation commission. REPRESENTATIVE G. DAVIS: ...okay, conservation commission, their expertise is strictly in, would be dealing in the first phase, in the findings aspect, whether there is rational to consider an adjustment rather than the economic aspect. Or is it just backwards? Number 419 REPRESENTATIVE BRICE: It'd be both. It could be neither. Number 420 REPRESENTATIVE G. DAVIS: Well, you said, my understanding is that Mr. Johnston indicated that they would, for the economic aspect, they would probably need to contract that. CHAIRMAN ROKEBERG: Representative Finkelstein. Number 422 REPRESENTATIVE FINKELSTEIN: Mr. Chair, just to clarify the, it isn't there at the first phase, which you're right, it's two phases, isn't a geologic decision, it's still an economic decision. The decisions that we're talking about here and about these royalties are economic decisions. The unitization and all the decisions about the fields, the geologic ones are made. Now the question is should we lower the royalties? So, the commission is going to have a problem with both those decisions. They're going to have to get new information, or new contractors, or some new expertise because they've never dealt with anything having to do with pricing of oil. Basically, decisions on what, what we should get for the state haven't been before them. And I'm not saying it's not possible they could get that, but I, I think there's a cost and I think no matter what they say, they can probably give these kind of additional duties, which something being done by the division, we should ask the division how much it's cost them in the past to make these decisions when an appeal has been made. I mean, it's, they're big decisions, you know. Multi, multimillion dollar decisions. CHAIRMAN ROKEBERG: Representative Ogan. Number 436 REPRESENTATIVE OGAN: Mr. Chairman. There's two things I like about having the, entertaining the idea of having the Oil and Gas Conservation Commission get involved in this. Number one, it involves a little bit more of the public process for public review. And number two, I think some oversight is appropriate given the fact that for example, Prudhoe Bay was, I believe if I'm not mistaken, was originally delineated -- is that an appropriate term for this -- at nine billion barrels I think they're going to end up producing twenty, or somewhere just about. So, I, I, you know, my concern with this whole process is the fact that because of maybe, again, I'll reiterate at this point that's unforeseen deals, they end up producing more than they anticipated, or the technology gets better with, they produce it, and I really want some safeguards that if the field, if we're going to give somebody a break because this field is being treated as a marginal field and then we find out that it has a heck of a lot more oil in it than we originally thought, there should be some oversight of that, and there should be some remuneration for the fact that that field turned out to be larger. Number 456 CHAIRMAN ROKEBERG: No question. We'll be discussing that, Representative Ogan, and let's call here any relevant factors, and we'll be working on that real hard when we get to it, but that's exactly right (indisc.). Let's see where, Representative Finkelstein. Number 460 REPRESENTATIVE FINKELSTEIN: Thank you, Mr. President. Just a, Mr. Chairman, I have a question for the commission. The, do you have the authority right now, I assume, to contract anyone necessary for you to complete your decisions? Is there any limit that exists now in your ability to contract? CHAIRMAN ROKEBERG: You're referring to Mr. Boyd? REPRESENTATIVE FINKELSTEIN: No, no. The Conservation Commission. CHAIRMAN ROKEBERG: The Conservation Commission. Dave, are you there? MR. JOHNSTON: Yeah (Indisc.). REPRESENTATIVE FINKELSTEIN: Well, let me ask you again, Dave, the, do you have any limitations on your ability to contact, contract for any expertise or background necessary in your decisions? Number 470 MR. JOHNSTON: Under our statute we're specifically allowed the ability to contract with third parties. The only limitations, of course, would be the availability of funds to the commission under the budget process. Number 473 REPRESENTATIVE FINKELSTEIN: And do you now select, generally, you use a contractor? Do you select them through a sole source process, or through bidding? Number 475 MR. JOHNSTON: No, we would go through the same procurement rules and go through the RFP process and solicit them. Number 477 REPRESENTATIVE FINKELSTEIN: And do you have a, any sort of cost recovery mechanism in the statutes to get from industry the cost of those experts? Number 479 MR. JOHNSTON: Well the, I guess the only cost recovery factor that we have is the fact that the state charges an Oil and Gas Conservation tax on the industry to fund the other programs of the commission. That's currently four mills per barrel of oil produced, and per fifty on state (indisc.) gas. Currently brings in about $2.1 million and our budget is currently about $1.6 or $1.7 million. Number 489 CHAIRMAN ROKEBERG: Oh, we got cush. Does the balance go on the general fund? MR. JOHNSTON: Pardon me? CHAIRMAN ROKEBERG: Does the balance go on the general fund? Number 486 MR. JOHNSTON: Yes. Those monies go into a special account in the general fund. Number 488 REPRESENTATIVE FINKELSTEIN: Well, Dave, isn't the amount available to you in a year the one point five? That's the amount we appropriate, not the two point one. Number 489 MR. JOHNSTON: No, no. You're right. The amount that our budget is about one point six right now. That's being considered by the legislature. Number 490 REPRESENTATIVE FINKELSTEIN: So, it's just sort of a, it's a happy coincidence that more money comes in. You couldn't use it unless we appropriate it? MR. JOHNSTON: Unless it was appropriated. That's right. Number 492 REPRESENTATIVE FINKELSTEIN: And in your decisions about use of a contractor, it's purely your decision? That's correct? There's no involvement by the regulated party. Number 494 MR. JOHNSTON: No, that's right. We would look at the case before us and then make the determination that a contractor was appropriate, and then we would start submitting the proper or current paperwork through the commission of the Department of Administration under which we are housed. That would then go to OMB for approval, and then presumably on to the legislature. Number 499 REPRESENTATIVE FINKELSTEIN: And is that, has that been a big issue? Has there been some, has there been in the past that any great level of unhappiness with the contractors that the commission has chosen? Number 501 MR. JOHNSTON: Well, it's been quite a few years since the commission has secured a contract. In fact, I think you'd have to go back quite a few years to the early '80s when we last employed, you know, contractors to aid us in an evaluation. Number 500 REPRESENTATIVE FINKELSTEIN: Do you recall at that time whether that, I mean, it seems to me that the system works for you, at least in the past. Number 507 MR. JOHNSTON: Well, I, I think, you know, there's just a problem, we worked pretty efficiently, but then the state was rolling in a lot of money now. I think the problem that we have today is just the reality that monies are tight and if, when I come before the legislature with a request it's closely scrutinized and many times I can make the case, but what our experience has also been is that with across the board reductions then you may grant the approval on one hand, but an across the board reduction wipes it out on the other hand. So, lately it's been a real difficult thing as you can all appreciate, the tight budgets. REPRESENTATIVE FINKELSTEIN: Thank you, Mr. Chairman. Number 516 CHAIRMAN ROKEBERG: As long as we're on that subject, Mr. Boyd, there is a fiscal note attached to this bill. Could you comment on that, and also, how you proceed with requiring applicants to offset that so Chairman Hanley doesn't have hemorrhage up there in Finance. Number 521 MR. BOYD: Mr. Chairman, we included a fiscal note of, as I recall, $91,000 plus some miscellaneous expenses as I recall, $15,000 that might require travel or whatever, for a petroleum engineer, a range 26A. In my experience, the analysis of these kinds of requests, again, using the Conoco perhaps as an example, requires looking at a lot of well data, petroleum engineers sometimes have economic backgrounds. The other money was strictly for travel or incidental expenses. At the moment, I don't believe we have anything to offset that cost although in unitization we've done that by charging five thousand dollars per unit application. I don't believe you can assess a high enough fee for each of these wells reduction applications to completely offset the cost. I would only add that if we believe that this project is a benefit and the new fields are developed that would not have been developed after this legislation, and I believe in a sense the program begins to pay for itself, hopefully many times over. Number 534 CHAIRMAN ROKEBERG: Then presumably it also (indisc.) industry paying $2 billion a year in taxes here. I'd really kind of like to get something for my money too, I think. You know, I am concerned about this cost and we should probably, you know, discuss it further and ... Number 538 MR. BOYD: Again, Mr. Chairman. It's a matter of how many applications are received, whether we can do it with, with existing staff among other things that may have to be done in the division. We do have two petroleum engineers, one of which is our unit manager, one an economist. A lot of these applications would begin to overload, although we do have the opportunity as the bill is written to use third parties. But I still believe to make the determinations of state's interests you need people that are working in the state to do that work. I really see the contracting as a very technical job, a number crunching type job, and not some philosophical advice that we're asking. Number 547 CHAIRMAN ROKEBERG: Someone you can, okay. You can even hire an accounting firm, if you will, rather than petroleum. Number 550 MR. BOYD: There are firms that probably would do this kind of work, and again, it's a matter of what kind of data is being submitted, but I would see it more as an accounting function than I do as a, as anything else. Number 552 CHAIRMAN ROKEBERG: Okay, are there any other questions for Mr. Johnston? Mr. Johnston, we look forward to getting your memorandum here and any further ideas you have on this, this regard, and I appreciate your testifying here. I'm going to ask a question of Mr. Boyd you might be interested in hearing right now. Mr. Johnston indicated he would recommend that the company hire that consultant because then we could avoid the RFP process and the state procurement code. What, what would be your initial reaction to that? You want to think about that? Or... Number 558 MR. BOYD: I'd prefer to talk to the commissioner about that, Mr. Chairman. Number 561 CHAIRMAN ROKEBERG: Why don't you get back on it. It seems like one way to expedite things. It also would take out the problem of who was being hired, but then perhaps the commissioner would have the veto then. He might want to give us a recommendation on two ways to go on that one. The, I'd like to just bring to the attention of the committee there's a number of other issues we want to get on. It's my intention right now to go until noon today. I notice, we notice for a carry over, we will not be meeting anymore today; however, tomorrow at 5 p.m. in the Beltz Room we will have a teleconference there and my intention would be to run about one hour there so we don't spend too much time. I know we're all busy with budget markups and various other things, but this to me I think still is the most important bill that the legislature is going to be considering this session and because of the testimony involved, what I intend to do, particularly for people who are in the audience or to let other people know is that I'd like them to, everybody to contact my Chief of Staff, Shirley Armstrong, and more or less try to make appointments that, for your testimony so we can make arrangements to make it the most convenient as possible. In addition, I, I hopefully will at least have a working draft of a committee substitute by the end of the week and as soon as we circulate it to the committee members and, you know, to get some input on that. So, that's kind of what's on my mind, to let everybody know, in case anybody has to get up and leave, so. And we will, like the, even the Friday night meeting, if in fact we have it, it will just be like an hour. I don't want to disturb everybody, but I think if we can continue and get this stuff cranked through and get the testimony behind us then we can start marking things up. And then we're going to generate questions probably from when we work on marking the bill up too, so we'll probably have to have, I see us going into just the first part of next week hopefully and maybe moving the bill next week if we can, but I know it's an inconvenience on everybody on the schedule, but I think this really is an important bill so, if there's any problems or conflicts please let me know. Okay, Mr. Boyd, as long as you're in the line of fire, what we, I'm kind of trying to move down the billing a little bit. Could you talk to the commissioner about, Representative Ogan asked a very good questions, that is, what, what (indisc.) and there's a question I had, is there any kind of setting up some type of criteria for best interest either in the regulations or at least a statement of intent from them, like you just did. I'd like to get some feedback later on about what that means and how we will even approach that because one of my concerns is that the language that was deleted from the bill previously set some standards that related to cost and reasonable rates returned, and things like that. And, as a result, you know, I think we need to discuss that further. As long as we're on that I might mention to the committee some of my struggles over this past weekend to try to confront what a reasonable rate of return is and so forth, if you will indulge me for a few minutes. One thing that, that caught my attention was reading the record, particularly of the Conoco application, was the fact that the people in the then Division of Oil and Gas Commissioner's Office to come up with a statement that they thought a reasonable rate of return was the average, three-month average of six-month T-bills, which at the time was between four but not in excess of six percent, and to say that that was a reasonable rate of return I find somewhat offensive. The reasonable rates of return are always in the eye of the beholder, and I think it's, so I thought, I struggled all weekend to get my brain churning and came up with an idea about taking a composite rate of various T-bills. For example, the two- year, ten-year and thirty-year note and going back five years, getting an average, making differentials between integrated producers on the North Slope, non-North Slope areas, old fields and adding different basis points to the, to the baseline composite rate; all these kind of things, you know, which ultimately, I think is like I was out tilting windmills and chasing, chasing the tail here a little bit because, and I've discussed it with various people. And that's one of the problems right now is what a reasonable rate of return is. I think certainly a reasonable rate of return for a older existing field would be lower than for a newer frontier field, which a company would have a higher hurdle rate for, and then, than an older field. But, I think that's part of the decision-making process the commissioner has to go through when he's making his findings. And what's, I've found problematic was in the particularly the Conoco application was that with the language that has been deleted in the last two, the reasonable rate of return in the lessee's total investment in the field have caused difficulties in the past. And I think that was the motivation on the part of the Governor to remove that, those things from the bill. And I, I've been trying to work to put them back in my own mindset, but I'm thinking maybe that that's wrong. I mean, maybe you guys are right. I don't know at this point. I'm only going through that process to try to understand it myself and everybody on the committee thinking hopefully it falls because what has struck me about this whole thing is the intention of this legislation. And I believe the intention of this legislation is to create an environment and also with economic inducements for the petroleum industry to, to risk and make the investments in their worldwide capital allocations. In other words, we need to send a message to the petroleum industry that we're open for business and we're very serious about this, and we want to in certain instances provide a modest inducement for them to come to Alaska and make those investment decisions and put their dollars here. And that's the message we want to send, but, and I think that's a proper message, but to try to define everything in detail is a problem because right now from a board room in London to the board rooms in L.A. there's going to be a reduced, and there's a difference in their hurdle rates, their expectations. Every company and every project is going to have a different set of numbers. There's no question about that. And here I think properly that the commission should have some discretion because you have to look at them. If you try to draft a bill here and try to be too specific then it's just going to cause more problems. TAPE 95-10, SIDE A Number 000 CHAIRMAN ROKEBERG: The commissioner needs to have that flexibility to make some of his decisions. And I just wanted to make that point to the members of the committee here what the process we've been going through here on working with the bill. The, I'd like to move on to what I think is the heart of the bill right now and I, I, we may not finish all of this, but plug in the, line 24 on page three, that range there, 23, the commissioner may, (indisc.) grant this section when really necessary to protect the state's best interests and also including increasing or otherwise modifying the state's royalty share any relevant factor such as the price of oil changes. To me, this, this is what I, almost the heart of the bill because this is what you end up doing in terms of a sliding scale or something like that. I'd like to ask you and to get the feedback from the commissioner as to whether you think that we should mandate a sliding scale price royalty scheme right into the bill, or we should come up with a statement of some of these various factors as they relate to this in a more narrative form. We haven't even... Go ahead. Number 049 MR. BOYD: Mr. Chairman. I believe my reading of the bill would be that the otherwise modifying would include the option for the commissioner to something on a sliding scale, again on a negotiated basis. And your second part, if I understand you correctly, your wanting more clarity on relative factors, we have presite(ph) one. CHAIRMAN ROKEBERG: Right, price. MR. BOYD: Price. I mean, obviously there are other things. Number 060 CHAIRMAN ROKEBERG: Well, as Representative Ogan rightly points out in our, even in the sliding scale of regulations now that production volume should be taken into account. I've had discussions with various people and you don't necessarily build this into one mathematical formulation, but it can be reduced to a quantifiable set of numbers or additional graphs and charts as you will. So I'd like to have, I, I know that industry is going to bring forward some statements in this area, so. And I see this as something that this committee needs to focus on and add to because by doing so I think we, we're building our fences a little more, and we're also helping define what we're looking for to give the commissioners a charge when we should be focusing on it. You know, obviously the production volume here is conspicuous by its absence, you know. We need to look at that. And also, I think we need to have, and I'd like to get your input on the clear statement that the commissioner could raise the royalty. And the reason I say that is this: In existing leasehold interests that have been granted to lessees there are stipulated royalty rates, be they 12.5 percent or be they higher and an argument could be made legally that albeit the commissioner may be granting a reduction initially, in, in, under section J here that we're doing, that a company would argue that later on or something you couldn't raise the royalty higher, for example, if oil prices were to go up. It seems to me that when a company comes in here and asks for this relief that they, they're opening up their leads and if the terms should be able to be modified throughout the lease. I think we need to get some feedback on what your perception of that is. And also, I think we need to stipulate right in here where it says modifying, including increase and your other items modified by the state's role is here. So, you can increase it? Number 114 MR. BOYD: Yes. I believe, Mr. Chairman, I believe line 23 gives the commissioner that ability. CHAIRMAN ROKEBERG: Right, okay. Also, there has been some conversations that I've heard from members in this (indisc.) that there are existing like 103 net profit leases in the state, or there's a large number. MR. BOYD: There's a large number. I don't know the numbers. CHAIRMAN ROKEBERG: Quite a number of leases that were issued over the years under the net profits type formulation and we've, I think we're going to receive some testimony requests from the industry that not only the basic royalty provision but also the net profits portion of the leases be able, the commissioner be able to adjust those? Well, let me tell the committee why. There's a number of leases out there that have a 90 percent net profit provision, which is real burdensome to a, to a marginal field situation, particularly if you're going to the chairman of the board saying, I need $300 million bucks to open up this field, but it has a 90 percent net profits field. Where's the beef? I mean, you know, there's not going to be any real return there if there's this high net profits provision. I mean, I, that's kind of the worst state case scenario, but I think we need to redress it, and I'd appreciate the input from the, the department on that. Go ahead, Representative Finkelstein. Number 148 REPRESENTATIVE FINKELSTEIN: On that, just on that point 'cause a lot of us, including myself, aren't very familiar with the net profit ones. Mr. Boyd, were they, I assume that there's somebody out there with a 90 percent net profit lease that it came through competitive bidding and other people bid 70 or 80 or 60 or 50 and they all lost. The person with the 90 is the one we want (indisc.) the others (indisc. - papers rattling) lower levels. They just didn't get the bid. Were they, is that how they did those? Number 157 MR. BOYD: Yes, Mr. Chairman. That isn't always the case. There was some certainly where the net profit share was the variable in the bidding process, and one of the variables, you'd have a fixed bonus perhaps, X number of dollars and you pay that regardless, and the variable that you would win the bid on was your net profit share and in a former life I worked for Marathon Oil Company and I can tell you that we were involved in some of that bidding and dropped out when it got above 70 percent, and there, are as Representative Rokeberg says, some out there with 90 odd percent net profit shares. But I believe there are also some leases where there is a fixed net profit share, where there was another variable. I just can't cite that off the top of my head, but there are some leases that carry, for instance, a 30 percent net profit share and that was agreed to at, there would be another variable that they won the bid on, but that would have been carried along with it. In fact, I can cite one in Thetis Island where it carried 12.5 percent royalty and a 30 percent net profit share. Number 176 CHAIRMAN ROKEBERG: Well, the net profit share, that's not, is that part of calculating the royalty payment? MR. BOYD: No. CHAIRMAN ROKEBERG: Or is that a separate... Number 178 MR. BOYD: No, it's a separate calculation on top of the royalty. If, in fact, the royalty is a variable in the bid. I mean, if the lease carries a royalty it has a royalty it has a royalty, and that net profit share is not part of the royalty. The net profit share will pay out when, in time, there is a net profit to count against. Endicott Field being an example that we're looking at now, which is a net profit share, wondering where the net profits. Number 187 CHAIRMAN ROKEBERG: Right. I mean, to me, I'd love to be able to utilize the net profit formulation even in this bill, but I'm very reluctant to do so because of the problems involved around the definition of what net profit is. To see, and have you had any litigation, or is there producing fields now? You said... MR. BOYD: Endicott. CHAIRMAN ROKEBERG: ...Endicott. Is that the only one that's under production with a net profit? MR. BOYD: I believe there are others that have producing, but I can't cite them off the top of my head. CHAIRMAN ROKEBERG: I mean, isn't there like, aren't there problems? Or is this, you... Number 199 MR. BOYD: The problem is what point in time, or how do you count it? How do you account for the profit? What is the profit? What is... The profit is net by definition. When does the state begin to collect its share? I think you have to look out in time. It is a bid variable. It seems to me the company has taken a longer view, decided that they can live with a certain amount of profit from this field and bid that as a variable. And then to come back and say, well, we'd like to reduce that, I think it's something that needs to have some hard thought. CHAIRMAN ROKEBERG: Well, I appreciate that. Representative Finkelstein. Number 208 REPRESENTATIVE FINKELSTEIN: This question is a step back, but we were talking before about increasing the ability to increase the royalties in some of these provisions. Under this bill, would you be able to increase it above the original level? The level that they (indisc.) that? Number 212 MR. BOYD: Mr. Chairman, Representative Finkelstein. In my view, that's exactly right. And even the current bill at utiniz... excuse me, current law allows us in a sense to do that now. We, we could, under unitization, under P, as an example, is Thetis Island where we removed a net profit share and increased the royalty rate from 12.5 to 16 2/3. Number 220 CHAIRMAN ROKEBERG: That is not true that under unitization provisions that you can modify the royalty payment, but it, historically, you've only increased it twice and never decreased it? Number 224 MR. BOYD: The word, the operative word, Mr. Chairman, is change. And it was discussions with the Department of Law and many hours of discussion with industry and others, we felt that the word change did not mean decrease, and there is no historical basis for decreasing whether you decided that was just because that was what you wanted to do or because everybody believes that you couldn't lower it. Number 231 CHAIRMAN ROKEBERG: Was that, well, obviously with the revision in P on page four of the (indisc.--background noise). That corrects that problem. Is that right? Number 233 MR. BOYD: Yes, Mr. Chairman, because really all, all pieces if you want a royalty reduction, if you want a royalty change in unitization go to J. Number 236 CHAIRMAN ROKEBERG: Right. And that's what the case law says about Conoco too in a way; that's one of the rationales. MR. BOYD: Conoco over... CHAIRMAN ROKEBERG: But we couldn't grant a reduction under unitization P because the higher standards were in section J so the division used that as a sword to deny Conoco their relief because they felt there was a higher standard in J than in P. Number 244 MR. BOYD: That was also... Mr. Chairman, that was also decided in court. That's part of it. There was also, Conoco's history is beyond just that decision because it goes back to, they didn't produce for two years. There are other parts and pieces of the Conoco decision which have a very long and fairly complicated history, which was eventually resolved in the court. CHAIRMAN ROKEBERG: So, you could look at historically with the exception of the Oxy Settlement, even with these provisions on the books for a number of years like from `78 is it? MR. BOYD: There have been provisions for royalty reductions since Statehood. Number 255 CHAIRMAN ROKEBERG: And so, in that period of time, since Statehood 40 years, there's been one reduction of royalty as a settlement in a law suit. Is that correct? MR. BOYD: That's correct. I believe there have been two or three denials. CHAIRMAN ROKEBERG: Yeah. But, even in unitization there've been increases in not(?) normal deductions. Number 259 MR. BOYD: That's correct. Again, we believe that the word change does not mean decrease. Number 261 CHAIRMAN ROKEBERG: Then that's what we're here about today -- change, isn't it? REPRESENTATIVE FINKELSTEIN: Mr. Chairman Number 263 REPRESENTATIVE FINKELSTEIN: This is the question I was trying to ask and I would like to ask it again of Mr. Shively, but your mentioning two or three. Of those two or three, one of them's the Conoco, right? One of them's the other one which revolves around the issue of past information, the Marathon case where they had past information, which didn't get pursued because they felt they didn't have past information, which I think is an easily corrected thing. So, we just don't have many examples in all of these. The only one we've really got is Conoco and what was the eventual disposition of that? What's happening with that, that lease currently? Is it under production? Number 273 MR. BOYD: Yes. I mean, well... REPRESENTATIVE FINKELSTEIN: Milne Point. MR. BOYD: ...Milne Point, it was denied. The field was sold to, Conoco's interest in the field was sold to BP who picked it up with the prevailing royalty rate. Conoco, in the court decision, or as a settlement of the court decision, we settled with Occidental saying, we don't owe each other any money for the past. Any of the bills we may think we owe each other are done, and in consideration of that we'll lower your royalty from 20 percent to 12.5 percent on, I believe it's six or seven leases. But now, British Petroleum, BP, has picked up the Milne Point field at the current royalty rates of Conoco, the 20 percent, and has within, I guess it's been two years now, has doubled the production of that field. Number 289 REPRESENTATIVE FINKELSTEIN: My point, Mr. Chairman, is it's hard to look at the past in condensed laws because we've only had one case where they actually had the information and they were able to proceed under the royalty reduction, and that case, although it was turned down, that same area is now in production at the existing royalty rates, so it would have been a bad decision if the state had lowered the royalties because we'd be losing a load of money, millions and millions of dollars. Number 293 CHAIRMAN ROKEBERG: I, I think I take somewhat of exception to that, Dave, because we were, when you're really talking right at the point of, of a policy decision that has been made. That may not necessarily be the case because the circumstances of BP and Conoco were different, plus the fact of the matter is when Conoco asked major application they asked to from major application they asked to go from 20 percent to 5 percent. It's like I don't know why they never bargained at a different rate or why didn't they just go down to 12.5 percent or something like that? Number 302 MR. BOYD: Mr. Chairman, I would only interject that there was a lot of discussion with the division on exactly that, of sliding scales and other ways to get to the end that were never -- a successful negotiation was never reached. CHAIRMAN ROKEBERG: I mean, we were talking with Conoco about that? MR. BOYD: Yes. CHAIRMAN ROKEBERG: And they didn't, because the record just shows the five percent. MR. BOYD: I don't know, Mr. Chairman, personally, whether that might be in the confidential section that would have required us to make those kind of negotiations revolving around confidential data from Conoco, and then trying to reach some agreement. I can find that out for you certainly, but I just, I just personally wasn't involved in that case, but I believe that, I know that the case, that there was negotiation about other ways to find a common ground. Number 307 CHAIRMAN ROKEBERG: Seemingly, you read the record and it looks like the five percent was there and there's not really much discussion about looking at alternate formulations and that's why I thought minor, major impact. I thought they might have been, being a little greedy and overreaching in their request, you know. So, perhaps not. Number 319 MR. BOYD: No, I believe we can say that we started off, the royalty rate was raised, you know, at unitization from 12.5 to 20 and then they reapplied for five, but there was an attempt to reach middle ground. It was never accomplished. Number 324 CHAIRMAN ROKEBERG: Wait a minute. You said that's where the 20 came from, that unitization? MR. BOYD: Um-hmm. CHAIRMAN ROKEBERG: Oh, very interesting. MR. BOYD: I forget what year that was. CHAIRMAN ROKEBERG: Oh, so they didn't bid that to begin with. MR. BOYD: No. CHAIRMAN ROKEBERG: So you guys jammed 'em up. Can you tell us why, just in a nut shell, why that would happen? Just generically. Number 327 MR. BOYD: Mr. Chairman, as I recall the history, this goes way back before me. CHAIRMAN ROKEBERG: No, I mean just as a rule. I mean, not, that's.... MR. BOYD: The rule, I believe anecdotally I would say that the idea was that they bought the leases at a time when oil prices were at a relatively modest level, and when the time for unitization came oil prices did nothing but go up and the commissioner decided that if you want to unit the state wants a larger share because the price of oil has nowhere to go but up. Of course, what happened was -- and I think everybody believed that -- I worked in industry at the time and everybody believed in the early `80s that the price of oil had nowhere to go but up, but of course, it does have places to go but up. And when it went down is at exactly the time when Conoco was trying to put Milne Point into production and that's when the royalty reduction request became in earnest. So, I think there was a good faith message on the part of the commissioner at the time to raise the royalty rate. It was agreed to by Conoco in terms of unitization to go to a 20 percent rate. Number 344 CHAIRMAN ROKEBERG: Now, isn't that, doesn't the tremendous leverage at that point in time when they are trying to unitize? MR. BOYD: Mr. Chairman, I just, I just simply don't know the... Number 347 CHAIRMAN ROKEBERG: I mean generally, not that case, but I mean, I'm talking about generically, isn't there, isn't it to the advantage of the lessees to unitize? MR. BOYD: Absolutely. And to the advantage of the state as well. Number 350 CHAIRMAN ROKEBERG: (Indisc. - both talking) has significant power right at that point to make demands which may be, how you say, avarice in nature, depending on your perspective. Is that, is that a fair statement, or... Number 352 MR. BOYD: Mr. Chairman, I guess I wouldn't care to respond to that. Number 354 CHAIRMAN ROKEBERG: Okay, I'm sorry. I appreciate that candor. Representative Finkelstein. Number 356 REPRESENTATIVE FINKELSTEIN: Thank you, Mr. Chairman. I wasn't attempting to say that the Conoco case was simple, but if there's, if we're going to look backwards there's so few cases to look back on. There's basically just one that had any sort of proceeding to it and then that case I think, you know, I was, could you conclude that, forgetting the interest of any one company, just looking at the state's interest and all overall maximizing revenue that the state's, it turns out by the way events have occurred since then that we now know that the right decision was made and we, by not granting the royalty reduction were actually maximizing state revenue because production is doubled under the 20 percent. Is that the case? Number 365 MR. BOYD: Mr. Chairman, again, it goes to every point I believe that's been addressed here this morning: whose crystal ball works the best? If you look into it early on it's hard to guess. Had we reduced the royalty would Conoco have stayed and done something else? Chairman Rokeberg is exactly correct in that this goes back to reasonable rate of return. What BP may do that Conoco can't do or because of its size, its ownership, and the pipeline, its ability to own its tankers, all has to be taken into the decision- making process. That's why I believe it's very difficult to come up with a formula. Conoco, on the other hand, if they had stayed who knows what other fields, they're a smaller company. They may have been able to move more quickly into something else. It becomes an impossible dilemma to somehow roll all this together, but these things do have to be considered. Number 377 CHAIRMAN ROKEBERG: Kinda to follow up on those points that Representative Finkelstein is making, isn't it conceivable that the industry didn't make applications for reductions because they felt that they'd just be spinning their wheels because of the prior history and the state's attitude at the time? Number 381 MR. BOYD: Mr. Chairman, I've not known very many companies that would ever be afraid to ask. CHAIRMAN ROKEBERG: But they didn't. I mean, there's, I mean, they thought their odds were pretty slim, (indisc.) I mean, is it fair to... Number 384 MR. BOYD: I could not speak for the company, Mr. Chairman. CHAIRMAN ROKEBERG: I know it is a speculative question. I appreciate that. Maybe we'll ask them when they testify. Representative Ogan. Number 387 REPRESENTATIVE OGAN: Thank you, Mr. Chairman. Something I would like to see just for future reference would be a breakdown of what fields that we already know are delineated and, and marginal, and what the costs, what the revenues would be if those fields were developed as marginal fields. Of course, I assume they aren't going to be developed 'cause they are marginal, but just to get an idea of how big a scope of a picture we have out there. I've got some pretty current maps I could bring in, or I assume DNR would have some too, but, I'd like to get a feel for what we've got out there. Number 398 CHAIRMAN ROKEBERG: Perhaps a list of the fields, I think. It may already be in the data and you can just maybe pull it out. We've got so much stuff it's hard to wade through it sometimes. Number 400 MR. BOYD: Mr. Chairman, if what Representative Ogan is asking for is a list of fields that are discovered but not produced, I believe we can get that to you, that part of it, fairly quickly. REPRESENTATIVE OGAN: Okay. MR. BOYD: When you get to delineated, then you become back to the bill, and I think again, in the same sense that you have to think of reasonable rate of return, it's something you have to look at, maybe on an individual basis. I believe that delineation is something that each field will have to stand on its own. Older, I don't want to use the word older, structural fields may be easier to delineate. You may have a greater, higher comfort level earlier on that they've delineated the field. The newer fields, what I'll say is the future fields of Alaska, the stratigraphic type fields I think require a different level of delineation before you have a comfort, that you're actually able to bring under production. So, I can certainly get you the list of those fields, but I think to have a further discussion we would need to sort of look at them individually and say, this one has this characteristic, and that one has this characteristic. Other things, distance from infrastructure, of course, it's hard to just shine a light on it and say, it's this kind of field. Number 418 CHAIRMAN ROKEBERG: Okay. In the interest of time, if you, if the committee will allow me, I'd like to just go over some other topics that we want to discuss later, and to alert the division and the committee members of where we're heading with this. The first is the, I'd say the development of a more narrative definition of the other relevant factors, and whether or not the commission would like to, my preference right now would be to stipulate the commissioner has a right to set a fee, a flat fee, or he also would have the right and would be, we prefer to see a sliding scale royalty based on royalty and oil prices, number one. And then additionally, that our next session would be the identification of other key variables that the commissioner would have to, have to review. And those would be things like capital cost, the amount of the reserves, rate of return without putting reasonable or anything else. Just a, to stipulate what these other variables could be so that a, perhaps even a secondary chart or scale could be developed that would be connected to the first, and so we can stipulate in the bill what those things would be, and that's kind of where I'm going on that one. These are the other relevant factors, and clearly the production and reserves of what they.... Then, I'd like to talk about the possibility of a five sets, five-year sunset clause in the bill that I would, I think somewhere like December 31st, 1999 or something. And we'll get some industry testimony on that. And, one reason I'm going back to the sunset clause is this: The recommendations in the historic record from your department has said that the sunset clause can be, the reason to have it would be as a message to the industry that you have this amount of time to, to come in and ask for your reductions and make the investments. So, I'm looking at the sunset clause as an inducement for near-term investment. That's, that's one reason. But, I'm willing to, you know, listen to both sides there. And then I would like to implement a stipulated reopener clause in the document and then get your feedback on that and then look at the prime(indisc.), maybe three years, five years or whatever. Number 460 MR. BOYD: Mr. Chairman, if I may. CHAIRMAN ROKEBERG: Yes, go ahead. MR. BOYD: Stipulate a reopener on which provision? On, on the raising, or the loan... Number 461 CHAIRMAN ROKEBERG: On anything. I would like to see like a bilateral right of reopeners by either party. MR. BOYD: I understand. CHAIRMAN ROKEBERG: But, not, you need to have certain stability there. You don't what everybody to just come in and, you know, day-to-day, from time-to-time. You need to have horizons of stability, if you will. And I'd like to have your comments on that, whether you think that would be workable or how that would work. And also, the Chair is contemplating, in their CS, removing section one, which is the Permanent Fund hold harmless, and if we did that in section one now, there is, because of the way it's drafted there's a floor which is relatively high bytake, six and a quarter percent, and I'd like to have your opinions on setting a floor at say 25 percent of the bargained for royalty in the lease. Number 479 COMMISSIONER SHIVELY: I can give you our position on that now. CHAIRMAN ROKEBERG: Oh, okay. COMMISSIONER SHIVELY: I mean, I think that's acceptable. In fact, I know it's acceptable. If you want to put a different kind of floor in terms of the total royalty instead of a Permanent Fund floor that, we have no problem with that change. CHAIRMAN ROKEBERG: I appreciate that. What do you think about 25 percent? Number 483 COMMISSIONER SHIVELY: I mean, you name a number. I have a number in there now that's either that or higher depending on the lease, so I don't think that changes the entire legislation. Number 485 CHAIRMAN ROKEBERG: One of my concerns about the floor, as written now, was that 50 percent really, I thought, impacted any kind of a bail out sliding scale on older fields. I think that's wrong. And it ties your hands in terms of formulating any kind of a agreement. But, however, by putting a floor underneath there, part of the (indisc.) again, but it's lower because it will recognize these older fields, but still says you can't, we're not going to get into this thing and get zero-zero revenue 'cause clearly, if you're, particularly in an older field, you're going to be ELFed out there anyway. You're going to be zero severance taxes. Number 502 COMMISSIONER SHIVELY: `Cause older fields also return with five percent revision. Number 503 CHAIRMAN ROKEBERG: I mean, there used to be a minimum royalty regulation too, so. I think it's been deleted or repealed, but, I mean, I'd like to, you know, it seems to me that you want to keep it the percentage rather than say stipulate three and an eighth percent or something, 3.125... COMMISSIONER SHIVELY: But then... CHAIRMAN ROKEBERG: ...so if somebody bid historically on the higher royalty in their bidding process they're going to have to live with that, you know. COMMISSIONER SHIVELY: (Indisc.) allows us to adjust to the whatever the... CHAIRMAN ROKEBERG: Right. COMMISSIONER SHIVELY: ...royalty base. CHAIRMAN ROKEBERG: Right. So, that's where I'd be coming from there. Let's see, there's, I see one more thing here. Oh yeah. In terms of the talking, go back to the subject of what I call the integrity of the bidding process. I would like to get the department's opinion on stipulating all future bidding that only the 12.5 percent royalty, I mean, you'd have to just stick with the 12.5 percent royalty. I guess the rationale being that I want to try to avoid the 'bait 'n switch' bidding by the part of the industry where they would involve a higher royalty if you had that as a flux(?) variable in the bidding processes, and come back later and ask for a reduction. And, that's the thing I've thought of that goes to this integrity issue. And any other ideas you have on this line, I mean I would appreciate it. I don't know. Any other questions of the committee? I'm ready to adjourn this thing until tomorrow at 5 p.m. in the Beltz Room for about an hour at which time we can take some additional testimony. I believe Mr. Quesnel(?), are you going to be there for tomorrow night? Is that (indisc.)? PAUL QUESNEL(?): (Indisc.) CHAIRMAN ROKEBERG: But you intend to testify tomorrow? Very good. I want to thank the commissioner and director both for coming, and this committee stands adjourned. Adjourned at 12:07 p.m.