Legislature(2013 - 2014)BARNES 124
02/18/2013 01:00 PM House RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| HB72 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 72 | TELECONFERENCED | |
| + | TELECONFERENCED |
HB 72-OIL AND GAS PRODUCTION TAX
1:03:49 PM
CO-CHAIR FEIGE announced that the only order of business would
be HOUSE BILL NO. 72, "An Act relating to appropriations from
taxes paid under the Alaska Net Income Tax Act; relating to the
oil and gas production tax rate; relating to gas used in the
state; relating to monthly installment payments of the oil and
gas production tax; relating to oil and gas production tax
credits for certain losses and expenditures; relating to oil and
gas production tax credit certificates; relating to
nontransferable tax credits based on production; relating to the
oil and gas tax credit fund; relating to annual statements by
producers and explorers; relating to the determination of annual
oil and gas production tax values including adjustments based on
a percentage of gross value at the point of production from
certain leases or properties; making conforming amendments; and
providing for an effective date."
1:04:28 PM
WILLIAM ARMSTRONG, President, Armstrong Oil & Gas, Inc., stated
the decline curve of the North Sea, which was similar to the
decline of the North Slope, was reversed in 1993 by a change in
tax laws. He compared the North Slope of Alaska to the Permian
Basin [Texas and New Mexico] during the mid-1950s, as they both
had about 5,500 wells, whereas the Permian Basin now had about
150,000 wells. He offered his belief that the North Slope of
Alaska could also support a similar number of oil wells.
1:07:11 PM
MR. ARMSTRONG reported that a massive oil boom was now in
progress in the Lower 48, including North Dakota, Texas, and New
Mexico. He declared that he had reviewed the PowerPoint
presentations by other groups, and, although he had been in the
oil business for 30 years, he still found the slides to be
confusing. So, he had decided to have a discussion, rather than
present a slide show. He shared that, as his was a private
company, it did not make press releases or talk to the public.
He said that he was talking from the heart. He opined that his
company had a unique perspective of Alaska, as it had been
working in Alaska for more than 12 years, and was now the most
active independent company in the state. He pointed out that
three of the most recent oil developments in Alaska had
originated in his company's office. Ten years ago, Pioneer
Natural Resources had partnered with Armstrong Oil & Gas and
they were currently developing the Oooguruk Island Field, the
first non-major, independent company development on the North
Slope. After this, Armstrong had partnered with ENI in the
development of Nikaitchuq Field. He reported that Armstrong was
the most active exploration company on the North Slope, and had
now teamed up with Repsol on a multi-hundred million dollar
exploration program. He stated that Armstrong had three oil
rigs looking for new production in new fields outside the Legacy
Fields. He offered his belief that Armstrong was the largest
lease holder in Alaska, outside the Legacy fields. He reported
that Armstrong was a private company, and paid for its own
exploration, leases, engineering, and analysis.
1:12:21 PM
MR. ARMSTRONG opined that Armstrong was one of the best oil
finding companies in the world, explaining that the typical
business approach was to do all the hard work, including data
mining, geophysical, and engineering, to find what he described
as "the next big idea." He shared that, although many of these
were dead ends, if one was worthwhile, Armstrong would collect
all the leases, buy the land, and then search for partners. He
noted that, as things in Alaska were so expensive, it was
necessary to partner with bigger, more capitalized companies.
He compared his company to a Chamber of Commerce for the State
of Alaska, as he was constantly extolling the benefits of the
state. He reported that the common response to Alaska was that
the state had issues, and it was often said to be a state that
had oil but was a terrible place to make money, or that it was
controlled by ConocoPhillips Alaska, Inc., or that the rules
changed regularly for taxes, for permitting, or for unitization.
He shared that the most important comment he heard was that the
state would take most all the profits.
1:15:24 PM
MR. ARMSTRONG declared there is an absolute boom going on in the
Lower 48. He surmised that it would single-handedly pull the
U.S. out of the current morass. He reported that most states
had similar production decline problems, but with the
advancements in technology, horizontal drilling, and stimulation
techniques, most states had turned around their declines. He
emphasized that this "boom has completely, totally,
unequivocally skipped Alaska." He stressed that there was only
one number to focus on and that was the number six, which was
the rig count, the number of rigs actively drilling in a region
at any one given time. He reported that Alaska had 6 active
rigs, whereas Texas had 819, North Dakota had 179, and Oklahoma
had 190. He exclaimed that, as stewards of the state,
legislators had to ask why Alaska only had six rigs actively
drilling. He declared that this was pathetic and anemic.
1:18:16 PM
MR. ARMSTRONG offered his belief that the answer was obvious,
that Alaska had to change on a number of levels. He emphasized
that the most important change needed to be with the fiscal
regime, which was why his company supported proposed HB 72. He
expressed that the proposed bill was not perfect, and needed to
be "tweaked in a number of ways, I think, to make it better."
He pointed out that things were always going to be more
expensive and slower in Alaska. He said that the message could
be changed, however, and he stated "don't tell me, show me."
1:19:55 PM
MR. ARMSTRONG announced that oil and gas companies were not
searching for oil and gas, they were searching for money;
therefore, the more money they made and the faster they made it,
the better. He relayed that "they're voting with their feet in
this state, and they're goin' somewhere else." He pointed out
that many opportunities still existed for oil drilling on the
North Slope; however the man-made investment framework inhibited
future exploration.
1:21:44 PM
CO-CHAIR FEIGE expressed his agreement that proposed HB 72 "was
a good starting point." He asked what could be done to improve
the proposed bill and increase the rig count.
MR. ARMSTRONG offered his belief that the proposed bill moved
clearly in the right direction. He recognized that there was a
battle between the three major oil companies and the State of
Alaska, expressing his belief that a state should "cozy up" to
businesses that contribute 90 percent to the state revenue. He
declared that, even though Armstrong Oil & Gas was a serious
competitor with the major oil companies, they needed something
to help them out within the existing units because that is where
there would be the fastest increase in production. He shared
that top personnel at the major oil companies had stated that
there was not the same return in Alaska, as was currently being
returned for investments in the Lower 48. He stated that there
was consensus among the oil producers that Alaska's Clear and
Equitable Share (ACES) "outside the existing fields is just
gonna kill us." He reported that the three major oil producers
were not as actively exploring for oil as Armstrong Oil & Gas,
and were instead focused on production in the existing units.
He remarked that, as things moved slowly in Alaska, there needed
to be an improvement for production timeframes, especially for
new entries outside the existing units. He offered his belief
that it was necessary to make investment in Alaska "better than
any other place," as there were expenses and time delays unlike
anywhere else. He declared that, as the state share from oil
production in Alaska was not a fixed amount, it was necessary to
make the share such that companies wanted to invest in Alaska.
MR. ARMSTRONG suggested that an increase to the gross revenue
exclusion (GRE), an extension of the qualified capital
expenditures (QCE) tax credits for a few more years before being
phased out, and a relief from corporate taxes until there was
pay-out would all help induce more oil investment in Alaska.
1:27:40 PM
REPRESENTATIVE JOHNSON asked if Armstrong would invest or
partner in new production if they were aware that ACES "was on
the horizon."
MR. ARMSTRONG replied that most companies, when looking at an
area to invest, would first determine if there was any profit.
He reported that his first investments in Alaska had been during
the Economic Limit Factor (ELF) tax system, which he declared
was an attractive situation for new entry. He emphasized that,
had ACES been in place, Armstrong would not have invested in
Alaska, and he opined that the other oil companies would have
had similar determinations.
1:29:03 PM
REPRESENTATIVE JOHNSON asked for a response to the comments that
new companies were investing in Alaska, therefore, ACES was
working.
MR. ARMSTRONG questioned who would make those statements. He
pointed to the rig count as evidence that ACES was not working.
1:29:21 PM
REPRESENTATIVE JOHNSON suggested that Mr. Armstrong listen, and
he would hear these comments regarding the success of ACES.
MR. ARMSTRONG offered that many things were said in Alaska by
people who were nervous about reprisal. He shared that his
experience had been that new producers did not invest in Alaska
because of ACES.
1:30:07 PM
REPRESENTATIVE P. WILSON suggested that Alaska increase
incentives for increased production, and asked whether it would
be worthwhile for Alaska to also incentivize getting more oil
rigs into the state.
MR. ARMSTRONG replied that production followed activity, and
that service contractors followed those companies "making the
action happen." He declared that a vibrant oil and gas industry
would induce the services to follow, and that he was not sure
how to incentivize for more oil rigs in Alaska without available
work.
1:31:56 PM
REPRESENTATIVE TUCK expressed his surprise that Mr. Armstrong
had not heard the comments regarding the success of ACES, and he
pointed to the activity on the North Slope. He expressed his
understanding that increased technology, especially for
horizontal drilling, required fewer drilling rigs. He
recognized that the seasonal limitations for drilling in Alaska
reduced the drilling schedules. He noted that Doug Sheridan,
managing director of Energy Point Research, had stated: "the
vast improvement in drilling efficiency has caused rig count
comparisons between now and prior periods to become less
meaningful." He asked if this new drilling technology was being
used in Alaska.
MR. ARMSTRONG replied that the new technology was "definitely
being applied a little bit." He expressed his agreement for its
increased efficiency. Referring to the testimony in support of
ACES, he suggested that this support would likely focus on the
credits, whereas any discussion for the take by the State of
Alaska would have a very different response from producers.
1:34:18 PM
REPRESENTATIVE TUCK asked about the impact of proposed HB 72, as
it eliminated almost all the credits.
MR. ARMSTRONG replied that this would have a lot of impact on
some companies as they had been operating under that business
strategy. He suggested that any elimination of the tax credits
should be phased, as business strategies were based on these tax
credits. He addressed the efficiencies of drilling, and
explained that the breakthroughs currently happening in the
Lower 48, long, lateral wells with multi-stage frac technology,
were just getting started in Alaska. He commented on the only
new technology attempt that he was aware of, a really modern
approach to a well on the North Slope, which he described as
"off the hook successful." He offered his belief that it was a
harbinger of future technology, if companies would come to
Alaska. He noted, though, that compared to those in the Bakken
Field, North Dakota, this oil well would be called "Bakken
Light." He opined that this was the future in Alaska, stating
that it would work fantastically.
1:36:49 PM
REPRESENTATIVE SADDLER surmised that ACES had been conceived as
a balance of upfront incentives and credits, with high taxes on
the production. He asked about the importance of tax credits
versus progressivity for the investment decision making by an
oil producer.
MR. ARMSTRONG replied that the credits really helped, but that
he was unsure if it had been tested, as the majority of
companies operating under ACES had not yet gotten to the point
of "really making big profits." Returning to the discussion of
rig count, he declared that this was a clear indicator that
something was wrong with the current tax system.
1:37:54 PM
MR. ARMSTRONG, in response to Representative Saddler, emphasized
that ACES needed to be completely revamped, suggesting that it
be deleted.
1:38:13 PM
REPRESENTATIVE JOHNSON asked to clarify that the rig counts
mentioned earlier were up to date.
MR. ARMSTRONG replied that these counts were correct, although
he expressed agreement that oil rigs had gotten more efficient.
He reported that there had been 300 rigs in the Lower 48 four
years prior, and that currently there were 1300 oil rigs. He
pointed out that this was not happening in Alaska.
1:39:03 PM
REPRESENTATIVE SEATON asked for the rig count in Alaska during
ELF.
MR. ARMSTRONG offered his belief that it had been higher than it
was currently.
REPRESENTATIVE SEATON pointed out that there had been a very low
rig count during the PPT and ACES legislation, which had led to
a production tax. He questioned whether there had also been a
very low rig count during the zero tax rates on many oil fields.
MR. ARMSTRONG noted that when Armstrong Oil & Gas arrived in
Alaska in 1999, the price of oil was $25 per barrel. Since that
time, the technological breakthroughs had been astounding, which
made it difficult to compare the current rig counts with those
at that time.
REPRESENTATIVE SEATON asked to ensure that discussion of
comparisons included the different parameters in Alaska.
MR. ARMSTRONG pointed out that there had been a low rig count
everywhere in 1999.
1:40:54 PM
REPRESENTATIVE OLSON asked if the regulatory climate had
improved, specifically for the Cook Inlet gas.
MR. ARMSTRONG replied that it was better, and he lauded
Anchorage Mayor Sullivan for changing and streamlining the
rules. He declared that a change for the tax laws was not a
silver bullet because the regulatory system and permitting also
needed to be changed. He offered an anecdote for one project in
Alaska compared to a project in Texas, declaring that Alaska had
to become more competitive.
1:42:23 PM
CO-CHAIR FEIGE encouraged Mr. Armstrong to provide additional
written testimony and suggestions for improvement to the
proposed bill.
1:43:19 PM
BART ARMFIELD, Chief Operating Office, Brooks Range Petroleum
Corporation, presented a PowerPoint. He reviewed slide 2, "HB
72 Support/Considerations." Directing attention to AS
43.55.023(a), he said that proposed HB 72 allowed the payment of
single year certificates, as opposed to 50 percent in the first
year, and then 50 percent again in the second year; however,
this would be eliminated after 12/31/13. He proposed either an
extension of this or the adoption of AS 43.55.023(l) which
should be applied to the North Slope. He also suggested a
redefinition of AS 43.55.025. Referring back to AS
43.55.023(l), he shared that this allowed a 40 percent tax
credit for intangible well work, as opposed to subsection (a)
which included the entire capital budget.
1:46:22 PM
MR. ARMFIELD addressed his support for AS 43.055.011(e) which
eliminated progressivity and maintained the 25 percent base tax.
MR. ARMFIELD pointed out that AS 43.55.023(b) was a credit that
his company would prefer to not receive, as it would mean that
his company was losing money in Alaska. He noted that
subsection (b) also expired, in its current form, at the end of
the year, and that those credits could not be cashed. He stated
that they would be applied, after two years, to the tax burden,
and could be used to offset that burden. He declared support
for the 15 percent interest on those unused credits.
MR. ARMFIELD shared that AS 43.55.024(c), which proposed to
extend the small producer credit to 2022, had been suggested by
his company.
MR. ARMFIELD declared support for the concept in AS 43.55.160,
although the proposed language "does not contain land that was
in a unit on January 1, 2003." He reported that this would
cause a problem for his company as his first two projects were
in a unit on January 1, 2003, and would not be eligible for this
credit.
1:48:25 PM
MR. ARMFIELD directed attention to slide 3, "Reasons for
Entering Alaska," which listed the reasons why his company came
to Alaska in 2000. He pointed out that oil prices had been very
low, and that the Lower 48 wells had struggled to break even or
recover operating expenses. He noted that, as his company was
very small, it did not warrant pursuit of a low oil price as the
prospect reserve base was not attractive. In the Lower 48,
deals coming through the office were few and far between and did
not justify the cash or the risk that would be entailed. He
reported that the big reserves, high production rates, and an
acceptable cost of doing business finally prompted the company
move to Alaska. He emphasized that the ELF tax policy was not
an impact consideration in 2000, as it was a common tax
structure in the Lower 48. He shared that his company had
arrived under ELF, had worked through the Production Profits Tax
(PPT), had been exposed to ACES, and was now preparing for a new
system. He explained that another factor promoting his company
move to Alaska was the expectation that industry cycles would
reveal that the big companies would lessen their efforts and
that the independent companies would "backfill that, as
traditionally been done" in other regions. He concluded that
these had been the reasons and drivers for the move to Alaska.
1:51:22 PM
MR. ARMFIELD presented slide 4, "What does Alaska have to
offer??" He stated that the world class reserve base in Alaska
in 2000 had been instrumental. He explained that because of the
current high oil prices, the technology discussed in earlier
testimony, and the advancements being made, the huge amounts of
reserves in the Lower 48 were now being opened up as they were
economical. He declared that the big reserves and big flow
rates were now swaying this current economic environment. He
noted that the Lower 48 had a more accessible infrastructure and
a better cost environment for cheaper well drilling than Alaska.
Referring to the relative oil price, he explained that the
differential had shifted, as Alaska oil was now trading at a
higher price, although developments in the Lower 48 could shift
the prices once again. He noted that he would discuss the
credit structure a bit later. He declared that he was not going
to debate the impacts of the tax policy, as it was the
perception of tax consequence that was more widely recognized in
the Lower 48. He addressed the final point on slide 4, the
"confidence in a 5 to 10 year business plan," and announced that
people had more confidence with investments in the Lower 48.
1:54:32 PM
MR. ARMFIELD presenting slide 5, "Why more players are not in
Alaska," stated that his company looked for three key elements
with new partners in Alaska. He listed an aggressive desire to
be in Alaska; a knowledge base to understand geology,
operations, lease administration, native relations, and
politics; and the financial capacity to execute in Alaska. He
declared that very few companies had all three of these
prerequisites.
1:56:09 PM
MR. ARMFIELD stated that the reality was that most companies
were "very content to stay in their own backyard, their core
business areas." He noted that high oil prices had taken the
focus off Alaska and onto the Lower 48. As most of these
companies had established relationships with investors and
traditional capital sources, there was not a compelling reason
for them to move to Alaska. He declared that most businesses
wanted to be able to plan and execute a five-year business plan,
at the least, yet the current changes made the process very
difficult. He emphasized that Alaska required very patient
capital, noting that his company had yet to make a revenue
stream in its 12 years in the state. He opined that Alaska was
an educational process for all three of the aforementioned key
elements, and that finding new investors for Alaska was a long
process.
1:58:27 PM
MR. ARMFIELD quickly reviewed slide 6, "Credits have helped keep
us in the game," which identified the four credit structures
that affected his company. He explained that the Qualified
Capital Expenditures (QCE) was the most relied on credit. He
confirmed that the carry forward loss credits (CFL) meant that
the company was losing money. He indicated that although the
small producer credit (SPC) was good, he hoped that his company
grew beyond the need for that credit. He expressed his
displeasure with the exploration incentive credits (EIC) and he
pointed out that his company did not qualify and had never
received this credit.
MR. ARMFIELD directed attention to slide 7, "AS 43.55.025
Limitations," which mapped the limits for the EIC credit. He
explained that the mass of wells in the center were Prudhoe and
Kuparuk, the small dots were individual wells, and the
surrounding ring was a three mile buffer around each well, with
a 25 mile buffer around the producing units. He noted that the
Brooks Range Petroleum leasehold position was right in the heart
of that, hence it would never be able to qualify for EIC. He
stated that it was necessary to move quite a way from existing
activity to qualify. He referenced slide 1, and reminded the
committee that he had suggested a redefinition for EIC that
would eliminate some of the limitations and make it more
accessible to activity.
2:01:26 PM
MR. ARMFIELD said that a similar chart to slide 8, "Tax Credits
History & Forecast," had been seen previously by the committee,
although this was a re-creation to show Brooks Range Petroleum's
share of credits that had been refunded. He pointed out that
the grey reflected the refunded credits, versus credits received
through a reduction to tax burden in red. He indicated that the
2013 Brooks Range Petroleum share, about $3 million, was stated
on the bottom left. He reported that the company had received
$69 million in credits, and he pointed out that, in 2011, his
was the only exploration company with a well drilling on state
land on the North Slope, although it was of minimal impact.
2:02:55 PM
MR. ARMFIELD provided slide 9, "Impacts to Mustang Development
Funding." He reported that an ice road was being constructed in
order to allow a gravel access road to the Mustang development.
Referring to the bar graph on slide 9, he explained that the top
section reflected the impact under ACES: the green bars were
CapEx to Brooks Range Petroleum, the blue bars were the capital
credit and loss carry forward contributions from the State of
Alaska, and the right side was a summary of those years. He
observed that the red box in the right corner showed that $205
million in received credits had a $1.2 billion revenue stream to
the State of Alaska with royalty, base taxes, and progressivity
under ACES. He indicated the lower graph, which compared these
same numbers under proposed HB 72, with the applicable share of
credits for the State of Alaska eliminated after 2013. This
would reduce the capital exposure from $205 million to $81.5
million, and would require Brooks Range Petroleum to increase
its funding request by $124 million because of de-sanctioning
under ACES.
2:05:32 PM
MR. ARMFIELD moved on to slide 10, "Forecast by Development
Project," which detailed five planned developments. The first
was the Mustang Development, with peak throughput of just less
than 15,000 barrels of oil each day, and revenue to the State of
Alaska of $1.2 billion. He expressed his hope that the peak
production of all five projects would reach 55,000 barrels of
oil each day, with revenue of $4.4 billion to the State of
Alaska. He clarified that this revenue included the $561
million of credit support under ACES. He explained that the
annual average was derived from the 15 year life expectancy of
each field, divided into the State of Alaska revenue of $4.4
billion, with an average return to the State of just under $300
million each year. He theorized that 10 new entrants of similar
size would replicate annual average revenues to the State of
Alaska of almost $3 billion.
2:07:24 PM
MR. ARMFIELD introduced slide 11, "Combined Development Projects
and Throughput Forecast," which projected the throughput
forecast of 55,000 barrels of oil per day, and the projected
capital budget of $2.2 billion. He reported that the royalty
and production tax would equal $4.4 billion of revenue to the
State of Alaska. Directing attention to the right side of the
slide, he explained that the projected leasehold royalty share
to the state was for 1/6, however this was a 33 percent bonus
over the 1/8 royalty share. He combined this loss of revenue
with the loss of credits in proposed HB 72, a projected loss of
revenue of $1.1 billion for the projects.
2:09:17 PM
MR. ARMFIELD indicated slide 12, "One Size Does NOT Fit All,"
and offered his belief that there were four tiers of players in
Alaska. He suggested that Brooks Range Petroleum was included
in the Exploration and Discovery Tier, whereas the New Entrants
Tier would include as yet unknown companies. He urged that the
committee consider all four tiers and the effects generated on
each tier, as it moved forward in reviewing tax policy.
MR. ARMFIELD concluded with slide 13, "HB 72 Support/
Considerations," which was the same as slide 2, and he asked
that the committee review these considerations.
2:10:46 PM
REPRESENTATIVE P. WILSON referred to slide 11, and asked if the
preference was for ACES over proposed HB 74 because of the
difference in royalty shares.
MR. ARMFIELD responded that the royalty shares had nothing to do
with ACES. It was "just a burden of fact that I wanted to point
out," although it was not in ACES or proposed HB 72. He
clarified that this royalty, in addition to the elimination of
capital credits, would reduce his revenue.
2:12:01 PM
REPRESENTATIVE P. WILSON asked for more clarification.
MR. ARMFIELD explained that the royalty share was determined by
his company's lease position of 1/6 on the North Slope, and, in
this case, it was 16.67 percent (1/6) of revenue, which was paid
to the State of Alaska. He reported that there were also lease
positions of 1/8 on the North Slope, which generated 12.25
percent of revenue to the state. He pointed out that, for these
projects, the revenue difference between 1/8 and 1/6 was $542
million, which he declared to be an additional burden that
needed to be considered, especially in consideration of the
elimination of the capital credits.
2:13:14 PM
REPRESENTATIVE P. WILSON asked to clarify that the royalty
differential of $542 million could be used by Brooks Range
Petroleum instead.
MR. ARMFIELD expressed his agreement.
2:13:27 PM
CO-CHAIR FEIGE confirmed that the State of Alaska had ways to
apply for royalty relief, as the original economics of the
project had been based on a previous tax regime, assuming that
proposed HB 72 was passed. He asked if the existing rules for
application for royalty relief were sufficient, or would
additional provisions be necessary.
MR. ARMFIELD replied that he had not yet modeled that, as
everything under ACES was the one-sixth royalty. He established
that an elimination of capital credits, with an increase for
near term capital needs, could require reconsideration of the
royalty position, if proposed HB 72 was passed.
2:14:38 PM
REPRESENTATIVE TUCK, referencing the carryforward tax credits,
noted that development was seasonal due to the weather. He
asked if 10 years was an adequate amount of time to reach
production, in order to take advantage of these credits.
MR. ARMFIELD responded it was a project-by-project calculation.
Noting that his company was currently 12 years into its projects
in Alaska, he suggested that it now had momentum, which would
reduce that timeframe between discovery and production
throughput.
2:15:57 PM
REPRESENTATIVE TUCK asked to clarify that the 10 year timeframe
was feasible.
MR. ARMFIELD said that he was comfortable with the time frame
under the current credit structure; however, with the increased
pressure to come up with an additional $124 million of capital
budget for one project, some of the projects would be delayed
due to a need for more upfront cash to move forward
aggressively.
2:16:52 PM
REPRESENTATIVE SEATON, expressing his desire to better
understand the limitations of proposed HB 72, asked if the
restriction on the effective use of the offered credits was a
hindrance when seeking financing.
2:18:07 PM
MR. ARMFIELD, in response to Representative Seaton, said that
although loss carry forward credits were important on the front
side, business decisions were not based on these credits. He
declared that the restrictions on credits would make it more
difficult, but that the company goal was to not qualify for
those credits.
2:18:50 PM
REPRESENTATIVE SEATON asked whether those credits were
meaningless for financing, as it was uncertain for qualification
for the credits. He surmised that cash flow was difficult to
project before the project came on-line and the taxes generated
would offset the 25 percent base rate for previous investment.
MR. ARMFIELD, clarifying that the project financers would view
the loss carry forward as an assured bankable position, stated
that this would present an uncertainty, although any business
model that projected continued losses over 10 years was not a
good funding prospect.
2:21:07 PM
CO-CHAIR FEIGE encouraged Mr. Armfield to provide additional
written testimony and suggestions for improvement to the
proposed bill.
2:21:52 PM
BRAD KEITHLEY, Partner, Oil and Gas Practice, Perkins Coie Law
Firm, stated the importance of this proposed bill for the future
of Alaska. He clarified that he was not speaking as a
representative for any clients, noting that he had been working
in the oil industry for 35 years and in Alaska since 1993.
2:23:27 PM
MR. KEITHLEY directed attention to the PowerPoint, titled
"Comments on SB 21/HB 72." Addressing slide 3, "Five things
...", he stated that there were five things to look for in oil
tax reform: competitive rates, durability, neutrality,
simplicity/predictability, and alignment. He declared that the
core goal for these five was to find a way to grow the pie,
slide 4, "Goal: Grow the pie." He declared that there was an
opportunity in Alaska to significantly improve the state's
position, and he referred to the chart on slide 4, which had
been taken from testimony submitted to the legislature in 2006.
He explained that the chart reflected three futures for Alaska.
The first of these production decline curves showed the result
if no additional investment in Alaska, which was a 15 percent
decline. The second curve was a 6 percent decline, which
reflected business as usual. He opined that the third curve was
the future of Alaska, which depicted a 3 percent decline, and he
pointed to the chart which shared the additional barrels of oil
for each change in decline. He declared that it was the
investment dollars that would drive each rate of decline. The
15 percent decline curve was the result of a zero additional
investment, the 6 percent decline curve was the result of an
additional in the ground investment for oil and gas of $1 - $1.5
billion each year, and the 3 percent decline curve would result
from a $2 - $3 billion investment each year. He noted that the
annual investment needed to increase in order to move the
decline curve further to the right, "growing the pie for the
State of Alaska."
2:26:30 PM
MR. KEITHLEY referred to slide 5, "Competitive Rates," and
pointed out that Commissioner Sullivan, Department of Natural
Resources, had projected a need to invest $4 billion in the oil
industry each year. Commissioner Sullivan had observed that
"we're not even close to that now... " He affirmed that the
five things previously mentioned, competitive rates, durability,
neutrality, simplicity and predictability, and alignment were
all necessary for Alaska to reach its future potential. He
declared that competitive rates were necessary to attract the
sustained, long term capital which would move Alaska's decline
curve to the right. He emphasized that, in order to attract
this capital, Alaska needed to be competitive across the full
anticipated long term price range, which were the range of
prices that the investment could pay out. He explained that a
long term investment necessitated pay out across the full price
range during the investment cycle.
2:28:02 PM
MR. KEITHLEY referenced slide 6, "Competitive Rates," pointing
to the chart on the upper right which depicted the cost of oil
as low as $70 per barrel, and he repeated that the fiscal regime
needed to be competitive across the entire price range. He
determined that a problem with ACES was its un-competitiveness
at the higher end of the price range, whereas proposed HB 72
could just reverse the problem. If it was not competitive at
the lower end of the range, this would just be an exchange of
one problem for another.
MR. KEITHLEY moved on to slide 7, "Durability," and announced
that this was a major problem with HB 72. He explained that the
substantial long term investments necessary to move the decline
curve to the right were a 15 - 25 year investment cycle. He
stated that a fiscal regime which changed its economics halfway
through a cycle was not a good investing scenario. He shared
that some countries used contracts to establish a stable fiscal
system, whereas other countries used economic stabilization
clauses which balanced any increase to taxes in one area with a
decrease in another.
2:30:36 PM
MR. KEITHLEY referred to the British Columbian discussions for
changes to its tax structure, slide 8, "Durability." The
premier of British Columbia had proposed a new tax on LNG that
could potentially have a significant effect on the investments,
yet the premier would not be able to discuss any of the
proposals considered until after the negotiations were
completed. She had stated "we have to make sure that, first of
all, we are getting maximum benefit for the people of our
province, and at the same time that we aren't imperiling their
business case, because if we want to be competitive, we need to
do that through the course of negotiations with (industry) so
that's what we're working on right now." He cited this to be
another means for durability, have the government negotiate with
industry for the long term durability. He pointed out that this
had been a significant problem in HB 72 or ACES.
MR. KEITHLEY called attention to the graph on slide 9,
"Durability," and declared that durability was suspect in
Alaska. He noted that these slides had been prepared for a
study by the Institute of Social and Economic Research (ISER),
which had analyzed the current state of the Alaska fiscal
situation and had reached this conclusion: "In its 10-year
fiscal plan, the state Office of Management and Budget (OMB)
projects that spending the cash reserves might fill this gap
until 2023." He explained that the Constitutional Budget
Reserve might fill the gap between this projected revenue and
the projected annually increased spending of 4.5 percent, which
he assessed as less than was historically recognized. He went
on to quote the ISER study: "Reasonable assumptions about
potential new revenue sources suggest we do not have enough cash
in reserves to avoid a severe fiscal crunch soon after 2023, and
with that fiscal crisis will come an economic crash."
2:33:30 PM
MR. KEITHLEY assessed that a producer reviewing the various
investments needed to move the decline curve to the right would
not invest in a situation that projected a fiscal gap in the
middle of the economic cycle, especially in a state which had
historically taxed the industry as a solution. He questioned
whether the current system was durable, offering his belief that
it would lead investors to have substantial concerns for doing
business in Alaska.
MR. KEITHLEY furnished slide 10 and slide 11, "Neutrality," and
he offered his belief that the government should not favor one
investment over another. He declared that market dynamics
changed too rapidly for government to attempt to second guess
the market. He endorsed that exploration and production should
be treated equally, and that the government should maintain
neutrality. He expressed that proposed HB 72 had better
neutrality than ACES, as it expanded incentives for both
exploration and production in new fields. However, the proposed
bill overlooked an important area, the significant potential to
realize improved recovery rates from inside existing fields.
"When production started at the Prudhoe Bay field the recovery
rate of the 25 billion barrels of oil in place was expected to
reach 40 percent. Today, using new technologies that estimate
has increased to more than 60 percent." He explained that each
1 percent of improvement in recovery rate equaled an additional
250 million barrels of oil. He referenced the chart on the top
right of slide 11, which listed the expected field size, and he
stated the necessity to not discourage work inside the fields to
increase the recovery rate.
2:37:12 PM
MR. KEITHLEY indicated slide 12, "Simplicity/Predictability,"
and offered his belief that proposed HB 72 was much simpler than
ACES, and that it measured well globally for simplicity and
predictability.
MR. KEITHLEY presented slides 13 and 14, "Alignment." He
defined this as the alignment between the state and investors
for growing the pie. He reflected that too often Alaska had
argued about the state's fair share rather than work to grow the
pie. He pointed out that there were many worldwide examples for
governments and investors successfully working together, and he
suggested a review of these arrangements. He opined that Alaska
relied on indirect policy tools, citing the use of the "carrot"
for fiscal investment, and the "stick" for regulatory action.
He offered his belief that a base rate of 25 percent would not
encourage investment. He offered an analogy that the State of
Alaska was attempting to drive the industry from the back seat
of the vehicle. He opined that better ways had been developed
for alignment with the oil industry. He pointed to Norway as a
successful example for increasing investment and growing the
pie. He cited Petoro as a leader in driving industry investment
and identifying new opportunities for Norway, which had resulted
in a much better success rate than Alaska for growing the pie.
2:39:54 PM
MR. KEITHLEY, recapping slide 15, "Summary of Conclusions,"
declared that proposed HB 72 was not competitive at a full range
of anticipated prices, specifically at lower prices. He
announced that durability was "a huge problem" as there was not
any mechanism to ensure durability with the Alaska fiscal
policy. He explained that neutrality still had some tilt, which
could discourage investment in existing fields to increase
recovery rates. He stated that, although the simplicity had
been substantially improved, the alignment was not configured
with the goal for growing the pie.
2:40:45 PM
MR. KEITHLEY concluded with slide 16, "Recommendations," and
offered three specific suggestions. First, he suggested
adoption of HB 72, with amendments to make it competitive across
all anticipated price ranges, and to provide GRE or similar
incentives for investments designed to increase ultimate
recovery rates in the existing fields, which he declared to be
the greatest source of oil that could be developed in Alaska.
He stated that it was necessary for the proposed bill to not
distort the economics for this recovery. He opined that the
committee "would be well served to identify fiscal policy
concerns in forwarding the bill to the Senate and the House
Finance Committees." He shared that, even should this become
the perfect tax bill, the oil industry would still project where
Alaska's fiscal policy was leading. With the projected fiscal
gap in 2023, as well as the ISER analysis, the oil industry
would still not want to invest in this investment cycle of
fiscal uncertainty. Lastly, he urged that the House Resources
Standing Committee hold hearings on a shift from the "royalty"
to the "co-investment" model, as Norway had done. He reported
that Norway had found the "royalty model" to be inefficient and
not attractive for the levels of required investment.
2:43:58 PM
REPRESENTATIVE P. WILSON, noting that the oil companies did not
have any reason to trust Alaska, asked how discussion could move
to co-investment, instead of "see what we can each get."
MR. KEITHLEY, in response to Representative P. Wilson, explained
that this was one of the reasons for the policy shift in Norway,
that co-investment with the oil industry was the best way to get
government and industry aligned.
2:46:06 PM
REPRESENTATIVE SEATON asked if the earlier witnesses would be
available for questions.
CO-CHAIR FEIGE said that he would ask.
REPRESENTATIVE SEATON suggested that it would be helpful for
committee, instead of individual, discussions.
2:47:10 PM
J. PATRICK FOLEY, Manager, Land and External Affairs, Pioneer
Natural Resources Alaska, Inc., offered to share the thoughts
and suggestions from Pioneer for what affected and motivated its
business, and how they made investment decisions for the future
in Alaska. He said that he would have comments and suggestions
specific to proposed HB 72.
MR. FOLEY presented an overview of Pioneer Natural Resources,
and stated that it had a $19 billion enterprise value, with 3500
employees, and a $3 billion capital budget with $2 billion of
cash flow for those operations, slide 4, "Pioneer Natural
Resources." He declared that the company was a leading
performer within its peer group, and initially had been a
partner with Armstrong Oil and Gas, in 2002. He reported that
success in the first year led to the development of the Oooguruk
oil field. He shared that there were about 70 full time
employees in Alaska, with an additional 150 - 300 contract
workers in-state, and an annual payroll of $14 million. He
listed the contract companies that Pioneer worked with in
Alaska, reported that the capital budget for 2013 was about $180
million, and that current production was about 6,000 barrels per
day, with a projection of 40 percent growth in the next two
years.
2:50:32 PM
MR. FOLEY considered slide 5 "Pioneer Alaska Profile: Oooguruk,"
and relayed that the company had drilled 11 exploration wells
resulting in 1 commercial project, Oooguruk, and that Pioneer
was the operator, with 70 percent ownership. He offered that
their experience had shown that there was about a one in ten
success rate for drilling. He revealed that more than $1
billion had been spent in development of Oooguruk, resulting in
production of 12 million barrels of oil, and credits of $270
million from the State of Alaska, equivalent to 7 percent of
total credits issues by the state. He declared the necessity to
preserve the credits, especially when modifying the proposed
bill.
MR. FOLEY referenced the fiscal policy timeline on slide 5, and
pointed to the changes in the last 10 years. He said that,
under ELF, the expectation had been for a production tax rate of
zero percent. However, under Governor Murkowski, PPT had been
introduced, which was a short lived modest improvement for the
oil companies. Shortly after this, the tax rate increased and
progressivity was introduced under ACES, all of which made for a
worsening fiscal metric for the oil companies. He declared the
need for stability and favorability with a tax program in order
to make investment decisions.
2:53:17 PM
MR. FOLEY indicated slide 7, "What's Next?" and explained that
the Nuna Project, an onshore drill site with offshore reserves,
was Pioneer's next development. This required extended reach
wells, and he pointed to the map on the slide, which outlined
the Pioneer leases. He reported that a second well had just
been finished, and he touted the immediate production success of
the first well, almost 4,000 barrels of oil each day. He
reported that, a year later, the well was still producing 1500 -
1700 barrels each day. He informed that the cost to drill each
well was $50 million, as the reservoir was "tight rock,
laminated, and requires very large fracture treatment." He
explained that the first well had caused a shift in business to
now drill long horizontal wells with large frac treatments. He
noted that fracs were measured by the volume of sand that was
pumped. He said that these were substantially bigger than any
in Alaska, although small in comparison to the super fracs in
the Lower 48.
2:56:07 PM
MR. FOLEY offered his hope to take the Nuna Project to Pioneer's
investment committee and request approval for $1 billion to move
"full speed ahead with development." He reported that this
project had an oil accumulation of 50 million barrels, with
projected peak production of 14,000 barrels each day. He opined
that these projects would not "be a needle mover for the State
of Alaska" and would not solve the financial problems, although
they would make a contribution. The biggest contribution would
come through jobs and the associated economic impact, he said.
MR. FOLEY moved to slide 7, "Competition For Alaska - An
Independent's View," and explained that this provided a
comparison for key investment decisions on Alaska's
competitiveness with the Lower 48, which included resource
potential, geologic risk, and oil bias. He observed that things
had changed since Pioneer arrived in Alaska in 2002, as the
resource potential, specifically with shale, in the Lower 48 was
now at least as attractive as Alaska. He pointed out that the
profitability report card was all weighted toward the Lower 48,
as projects had less risk, faster cycle times, faster payback,
and easier execution with greater operational flexibility. He
identified that Pioneer had an island development that would run
365 days a year, and that it could not be started and stopped,
which was in contrast to the Lower 48 projects which could react
monthly to changes in the market environment by moving drilling
rigs or adding people. He declared that the Lower 48 had a lot
more operational flexibility.
2:58:57 PM
MR. FOLEY provided slide 8, "Pioneer Competitive Resource
Opportunities," which compared the various Pioneer shale oil
projects in Texas competing for investment funding against
Alaska. He reported that these areas would drill more than 300
wells, with a $2.5 billion budget for the 40 operating drill
rigs. He shared that there were 20,000 locations to be drilled.
By comparison, there were about 6 wells drilled annually in
Alaska. He offered this, not as a criticism of Alaska, but in
the hope to craft better fiscal policy for more attractive
investments in Alaska.
3:00:47 PM
MR. FOLEY reviewed slide 9, "2013E Capital Spending and Cash
Flow," and stated that Pioneer had a $3 billion capital budget
for 2013; although the majority would be spent in Texas, $190
million, about 7 percent of the total drilling capital, would be
spent in Alaska. Describing the source of the capital budget,
he noted that $2 billion would be sourced from cash flow, and
about $600 million would come from a joint venture with
Sinochem, an arm of the Chinese national oil company. The
remainder, $400 million, would be raised from sales of company
stock. He commented that, as Pioneer was an independent
company, it was important for them to manage its debt, and even
a low interest loan would increase debt. For this reason,
capital credits were important to his company.
3:03:05 PM
The House Resources Standing Committee recessed until 5:30 p.m.
5:31:49 PM
CO-CHAIR FEIGE called the House Resources Standing Committee
meeting back to order at 5:31 p.m. Representatives Hawker,
Johnson, Olson, Seaton, P. Wilson, and Feige were present at the
call back to order. Representatives Tarr, Tuck, and Saddler
arrived as the meeting was in progress.
5:31:58 PM
MR. FOLEY continued his presentation with slide 10, "SB 21/HB
72," and announced that the proposed bill had derived from the
Governor's four guiding principles for changes to tax policy:
to be fair, to stimulate new production, to be simple and
balanced, and to be competitive. He confirmed support for each
of these goals, although there were some changes necessary in
the proposed bill to accomplish each of these goals.
MR. FOLEY established that it was necessary for the North Slope
oil producers to have a healthy industry with a tax policy that
motivated investment. He affirmed that positive aspects of the
proposed bill included the elimination of progressivity,
extension of the small producer credit, gross revenue exclusions
(GRE) for the fields outside the legacy fields, and an
escalating loss carry forward. Some of the negative aspects
included the loss of capital credits and the lack of inclusion
of GRE for the legacy fields.
5:34:55 PM
CO-CHAIR FEIGE asked for a suggested change to the loss carry
forward credit.
MR. FOLEY said the rest of his presentation will be explaining
the costs and advantages, although the upside does not match the
downside, at least for a company like his.
5:35:49 PM
MR. FOLEY introduced slide 11, "Relative Rankings," and reviewed
the companies in Alaska. He listed Exxon as a $400 billion
market capital company, Shell, Chevron, and BP as $200 billion
companies, and finally Pioneer, a $19 billion market capital
company. He stated that the financials for private companies
were not public. He suggested that tax policy to help the state
move forward would incentivize all of the companies, not just
some, so that all the companies were flourishing and investing
in projects throughout Alaska. He reported that the development
from first idea to first oil could be 7 - 10 years, as modeled
by the Oooguruk development. He offered his belief that new
production in Alaska during the next decade would most likely
come from one these companies already in Alaska.
5:37:36 PM
MR. FOLEY addressed slide 12, "What is an Independent Oil and
Gas Company?" He defined an independent company as a non-
integrated oil company, which focused on the exploration and the
production side of the industry, with no refining or marketing.
He stated that the 18,000 independent oil companies in the US
came in all sizes, drilled about 94 percent of all the oil and
natural gas wells, and accounted for 2.1 million jobs. He
acknowledged that independent companies had different financial
motivation, in so far as investors were rewarded for growth and
debt management, not for dividend or return. He referenced a
quote by Doug Smith, which stated that small companies were
important because they spend money, they offer jobs, and they
help with the economy.
5:39:24 PM
MR. FOLEY furnished slide 13, "Eagle Ford Operators and
Companies," and explained that the core business for Pioneer
included heavy involvement in Eagle Ford. He pointed to the
large list of companies actively involved in Eagle Ford, noting
that some of them were also doing business in Alaska. He asked
what could be done with the tax policy to encourage these
investors to come to Alaska. He directed attention to the chart
on the right of slide 13, which graphed the required Capital
Expenditure per barrel and Operating Cost per barrel, revealing
that Alaska projects were more expensive than projects in the
Lower 48. He reported that the Pioneer production costs in
Oooguruk would be about $15-$20 per barrel for capital
expenditures and about $10-$20 for operating costs per barrel.
He pointed out that, in Alaska, there was a lot of water per
barrel, which caused an increase in operating costs.
5:41:07 PM
MR. FOLEY moved on to slide 14, "SB 21/HB 72: Econ One Initial
Project Evaluation," which represented a conceptual project for
a $1 billion capital investment for 50 million barrels of oil.
The slide evaluated the project using ACES and proposed HB 72,
using common operating expenses, capital expenditures, and
rates. This conceptual project would be $115 million better off
using the new tax idea in proposed HB 72 rather than using ACES.
He said that it did not describe the opportunities presented for
Pioneer.
5:42:27 PM
MR. FOLEY detailed that slide 15, "Typical New Project Spend
Profile," depicted that same project for a $1 billion capital
investment for 50 million barrels of oil with a spending profile
that matched the various opportunities presented to Pioneer. He
explained that there was very substantial capital expenditure
for the first eight years, which was followed by the peak
production, and corresponding revenue. He compared this to the
previous slide, which depicted capital expenditure for four
years, and then peak production, noting this difference for the
typical Pioneer projects. He confirmed that this information
had been shared with Econ One and PFC for their projections, and
that he wanted the opportunity to share this overview with the
committee to evaluate in connection with the proposed tax
changes.
5:44:13 PM
MR. FOLEY explained that slide 16, "New Entrant - Stand Alone
Project," was a reevaluation of the project for a new entrant,
slide 17, "Current Small Producer," was for a company similar to
Pioneer with small base production, and slide 18, "Current Large
Producer with GRE," was for a much larger company than Pioneer,
by a factor ten. He explained that the grey bars on the chart
showed the negative and positive cash flow on a discounted
basis, under ACES. The red bars reflected proposed HB 72, and
that there was 20 percent more negative investment because there
was not the benefit of credits. He stated that the upside was
for lesser tax.
5:45:17 PM
CO-CHAIR SADDLER asked for clarification to the color bars.
MR. FOLEY replied that the grey bar represented ACES, whereas
the red bar was the additional negative from the loss of
credits, and the green bar was the benefit of the lower tax
rates. He explained that this was discounted at 12 percent, in
order to exactly match the earlier Econ One data on slide 14.
He disclosed that the project for a new entrant was $92 million
worse off with the proposed bill, than under ACES, as the loss
of credits far outweighed the benefit of the lower tax rate.
5:46:48 PM
MR. FOLEY moved on to slide 17, explaining that this premise for
a current small producer was similar to the base production of
Pioneer Natural Resources. He observed that this project would
be $66 million worse off with the proposed bill than under ACES.
He explained that the current small producer had better results
than the new entrant because, although all the credits were
gone, the loss carry forward allowed the company a lower tax
rate. The current producer would have the benefit of paying a
lower tax rate sooner than a new entrant, hence a greater value.
5:48:11 PM
MR. FOLEY, in response to Representative Seaton, clarified that
currently Pioneer did not pay tax, as it was a profit-based tax
and Pioneer had not yet made a profit. He reported that Pioneer
had made investments in Alaska since 2002, that every year
Pioneer was a net investor in the state, and that the company
had not yet generated a profit. He projected that, depending on
the price of oil and the future investments, the company would
turn the corner, and pay a production tax, in a couple of years;
however, the Nuna Project could push it out several more years.
5:49:06 PM
REPRESENTATIVE SEATON asked to clarify that continued projects
would extend the net operating loss, and that, under proposed HB
72, the net operating loss would disappear after ten years.
MR. FOLEY, in response, acknowledged that continual investment
would postpone the tax.
5:50:39 PM
REPRESENTATIVE SEATON asked to clarify if this was a
disincentive for project expansion, as it was still a net
operating loss with no tax due, yet proposed HB 72 allowed the
loss carry forward to disappear if not used against the taxes
within ten years.
MR. FOLEY replied that he would need "to think about that a
little bit."
5:51:36 PM
CO-CHAIR SADDLER asked to clarify if both ACES and SB 21 [HB 72]
were included in the grey bars.
MR. FOLEY suggested ignoring all the red and green bars, and to
only look at the grey bars, which reflected the impact of ACES.
He explained that the red bars, which increased the negative
costs as there was no longer a credit, and the green bars, which
increased the positive cash flow as there was a lower tax rate,
reflected the impact of the proposed bill.
CO-CHAIR FEIGE asked to clarify that the cash flow was to the
company, and not to the State of Alaska.
MR. FOLEY acknowledged that the cash flow was to Pioneer.
5:52:43 PM
MR. FOLEY moved on to slide 18, announcing that this was a
reevaluation of the project for a large producer, defined as ten
times the operating base costs of Pioneer. He declared that
there was not an attempt to mimic a legacy owner, but rather a
company that could enjoy that benefit of the loss carry forward
sooner. He reported that this producer would only be $13
million worse off with the proposed bill than under ACES. He
emphasized that this was discounted at 12 percent, even though
Pioneer projected a 10 percent discount. He acknowledged that
the higher rate increased the gap, overstating the difference
between the two regimes, but explained that the Econ One
presentation had also used 12 percent so he was attempting to
maintain a consistent comparison.
5:54:12 PM
REPRESENTATIVE P. WILSON asked if Pioneer would be included as a
large producer.
MR. FOLEY replied that Pioneer would be considered a small
producer. He directed attention to slide 19, "New Field: ACES
vs. SB21/HB72 Summary," which was a comparison for each type of
producer.
REPRESENTATIVE P. WILSON asked to clarify that the large
producers were ConocoPhillips Alaska, Inc., British Petroleum,
and others.
MR. FOLEY explained that those aforementioned companies were
substantially bigger, and that the example was for a company
with daily production of about 40,000 barrels per day, ten times
the production of Pioneer.
REPRESENTATIVE P. WILSON asked if he was referring to the
producers listed on slide 11.
MR. FOLEY replied that slide 11 was just an attempt to reflect
"the relative size of the current players." He stated that his
point had been to have a tax policy that was attractive to all
the producers, as each was motivated by different things. He
defined the new entrants as companies with no base production,
and that it would take a long time to realize any benefit for
the loss carry forward credit. The small producer was similar
to Pioneer. The large producer was a company ten times the size
of Pioneer. He summarized that the exact same project placed
with different investors would have different financial
outcomes, possibly unintended, under proposed HB 72.
5:57:23 PM
MR. FOLEY offered his belief that there were several complicated
restrictions on how that loss carry forward balance escalated,
and he listed that neither the first two years or the last year
were counted, and that there was not any unpaid tax from the
small producer credit. He clarified that not all the
expenditures would grow at 15 percent, and it was truncated at
the end. He concluded that the escalation of the loss carry
forward did not offset the value of the credits.
5:58:24 PM
REPRESENTATIVE TUCK asked to compare the presentation by Brad
Keithley for decline rates before the net present value, so no
discount rate, with the Pioneer estimate without the 12 percent
discount.
MR. FOLEY, in response to Representative Tuck, said that the
result would be "very, very different." He explained that this
presentation work was done by Palantir, an economics evaluation
consultant company. He reported that Palantir had built a
commercial model to exactly match both ACES and the proposed
bill. He declared that the tax structure was very complicated,
and not a simple cash flow analysis, as it was a profit tax
based on the entire integrated business. He opined that ten
model developers would each have a different result to this.
REPRESENTATIVE TUCK asked to clarify that it was necessary to
have a discounted rate to compare the models.
MR. FOLEY, in response, offered his belief that it was
absolutely necessary to look at it on a discounted basis.
6:00:45 PM
REPRESENTATIVE SEATON asked to clarify that slide 11 viewed the
companies by their capitalization size, whereas the other slides
recognized companies by production size.
MR. FOLEY expressed agreement, noting that slide 19 had nothing
to do with the size of the company, but everything to do with
the in-state investment and the base tax rate.
6:01:39 PM
MR. FOLEY returned attention to slide 19, and explained that the
gap would be less if it modeled at a 10 percent discount,
instead of 12 percent.
6:02:11 PM
CO-CHAIR SADDLER asked to clarify slide 16, that a new entrant
would lose $92 million more under the proposed bill than under
ACES.
MR. FOLEY expressed agreement. He clarified that this did not
describe every project in Alaska, just the projects in which
Pioneer was involved.
6:03:02 PM
MR. FOLEY provided slide 21, "Industry Spending on North Slope,"
explaining that this was a five year snapshot of all the
expenditures eligible for credits, about $2 billion each year.
The red bars reflected that amount spent on facilities, the
green bars showed the amount spent on development drilling, and
the orange bars showed the amount for exploration drilling. He
projected that, on average, about 42 percent of all the capital
expenditures was spent on facilities, with another 43 percent
spent on drilling development wells and 12 percent on
exploration wells. He declared that every development well had
resulted in new oil, and he opined that a lot of the facilities
capital was spent on new installations or to refurbish existing
facilities. He endorsed that every dollar spent helped the
state with its production. He indicated that, although
exploration was a risky business, without it there would not be
any new oil production.
6:05:06 PM
MR. FOLEY declared that the tax rate in the proposed bill was
too high, and that the credits really mattered, as it minimized
the capital investment. He encouraged that the tax rate be
lowered. He observed that, although the Pioneer projects would
not save Alaska, it was a contributor. He said that Pioneer
would bring jobs, and he referred to the multiplier effect,
whereby every job in the oil field resulted in nine more
indirect jobs. Referring to slide 22, "Fostering New
Production: Why Credits Matter," he informed the committee that
credits helped with investment, as there would be more wells,
more oil, more royalty, and more throughput.
6:07:31 PM
MR. FOLEY concluded with slide 23, "HB 72 Closing Thoughts." He
stated that the proposed bill had many favorable attributes,
including the elimination of progressivity, and extension of the
small producer credit, but that the tax rate was too high. He
observed that the playing field would never be level with the
current players, because of the infrastructure, people, and
data, but that the small producer credit did help level that
playing field a little bit.
MR. FOLEY offered some suggestions and he encouraged the
maintenance of a credit program, even if it meant including some
targeted investments to encourage. He said that a credit for
drilling new wells, or a credit for a new project with new
facilities, even for a limited time, would encourage it. He
pointed out that the gross revenue exclusion did not apply to
the legacy fields, so there was not any stimulation or
motivation for additional investment in those fields. He opined
that new production was necessary in both the existing and new
fields, as "there's a ton of additional oil resource" and it was
necessary to motivate the three big producers.
6:09:37 PM
REPRESENTATIVE TUCK relayed that the bar needed to be at a
competitive level, in order for investment to occur, and that
the existing fields had the quickest potential for putting more
oil into the pipeline. He asked if bringing tax credits closer
to the wellhead would enable more investment.
MR. FOLEY, in response, replied the guiding principles of the
governor's bill were to incent new oil production, and that
could be accomplished by giving credits for drilling wells, and
developing existing facilities. He encouraged a system that was
fair and balanced for all the diverse investors.
6:11:22 PM
REPRESENTATIVE SEATON relayed that the elimination of the
capital credits was due to an upcoming payout of almost $1
billion. He asked if the relationship of the percentages in
investments between facilities, developmental well drilling, and
exploratory well drilling was remaining steady.
MR. FOLEY replied that he was not an expert, and merely reviewed
this as data produced by the Department of Revenue (DOR). He
opined that this data could be used for future projections,
though he had difficulty believing the capital expenditures
would increase from $2 billion to $5 billion in the next few
years. He applauded the possibility for a doubling of
investment, which would lead to a greater production, and that
was exactly what the state should be motivating.
6:13:40 PM
REPRESENTATIVE SEATON expressed his agreement, except that it
was necessary to balance the reduction in revenue from the
elimination of progressivity. He listed the aforementioned
problems cited by Mr. Foley that would not stimulate new
investment, as new investors would be worse off with the
proposed bill than with ACES.
MR. FOLEY commented that the information he had presented was
just sharing the oil world view through his eyes. He stressed
that the credits were very important to his company. He pointed
out that the legislature was the policy maker and that the
industry would respond to whatever policy was approved; however,
if the intent was to incent new oil wells, then design a program
that rewarded the behaviors to produce new wells.
6:15:44 PM
REPRESENTATIVE SEATON asked whether he was projecting that there
would be a greater margin than $30 per barrel, as a small
producer. He opined that Pioneer would not be paying any
progressivity in the near future on any of the expansions.
MR. FOLEY replied that Representative Seaton had hit a key
point. He declared that paying a lot of taxes was desirable in
a profit based system. He explained that the system encouraged
investment, because, as a harvester without capital investments,
there would be the difficulty of high taxes and high
progressivity. He pointed out that the smaller projects were
just not that profitable. With the profit based tax, and
without progressivity on a new small marginal project, there was
a focus on the credit rather than the reduction in the tax rate.
REPRESENTATIVE SEATON declared that he better understood the
position.
6:18:46 PM
CO-CHAIR FEIGE offered his belief that the committee understood
what Mr. Foley was saying about the legacy fields, that there
was a lot of oil to still be gained. He recognized that the
gross revenue exclusion for the new projects may not be as
achievable in the legacy fields. He stated that an incentive
needed to be tied to new production, and it was necessary to
define "new oil," which was more difficult to define in a legacy
field. He asked if there was a methodology to identify or
define the percentage of new oil in a legacy field.
MR. FOLEY replied that he was not the right person to comment on
this; however, he stated that new opportunities and projects
existed on the North Slope, and it seemed like the same rule
should apply everywhere, as it was all new oil.
6:20:46 PM
REPRESENTATIVE SEATON commented that the gross revenue exclusion
(GRE) for a specific development was a "big reduction in tax
rate," and, depending on the expenditures and as it came off the
top, could have a big effect on profitability. He asked to
clarify that the GRE for proposed specific dates and specific
units was "the administration ... sitting there trying to pick
winners and losers." He offered his belief that not all
projects were considered the same based on their economics, but
instead, whether they fit into a window created for a certain
production. He asked if Mr. Foley saw that same issue for who
would receive a GRE.
MR. FOLEY responded that the current proposal rewarded different
players differently. Although he was unsure whether it picked
winners and losers, he declared that it depended "who you are
and where you are," whether inside or outside a legacy field,
current tax payer or not. He stated that everyone should be
treated the same. He expressed his agreement that the GRE had
the effect of lowering the tax rate. He endorsed the need to
grow the pie by creating a fiscal environment which encouraged
incentive and resulted in new oil production. He affirmed that
a lower tax rate would create a bigger tax base.
6:23:50 PM
REPRESENTATIVE SEATON expressed his understanding for the
implications of the tax rate, though he considered that the GRE
was very complex as it changed tremendously depending on the
base economics of the project. He explained that taking
something off the top related differently depending on the
economics of the project. He suggested visiting the tax rate
rather than the GRE, which had multiple facets dependent on the
economics of each project.
MR. FOLEY expressed his agreement that this was complex. As it
was a profit-based tax, the elimination of some things through
GRE in the calculation of profit resulted in lower taxes. He
declared the need to keep it simple by lowering the tax rate,
changing progressivity, and creating credits for the encouraged
investments.
6:25:38 PM
REPRESENTATIVE JOHNSON asked if Pioneer would be in Alaska,
knowing what they know today.
MR. FOLEY responded that, when Pioneer came to Alaska in 2002,
it had a very strict need for an oil project, and that Alaska
was a perfect strategic fit. Since then, Pioneer's
opportunities in Texas had exploded and he declared "without any
regard for the tax system, would we be here today? I don't
know." He noted that Pioneer came to Alaska under the ELF tax
system of zero tax, which then became a 20 percent profit tax
which was better because of the credits and the timing.
However, as the tax rate went up, it got worse and worse. He
confirmed that costs were higher in Alaska, and that the fiscal
environment was not as attractive.
6:27:04 PM
REPRESENTATIVE JOHNSON asked whether he considered ACES to be a
success.
MR. FOLEY respectfully declined to comment.
6:27:38 PM
REPRESENTATIVE TUCK asked if Pioneer had been able to use the
transitional investment credit and the royalty relief during the
changes in tax systems.
MR. FOLEY said that Pioneer did have investments when PPT
originally came into play, and, although they were entitled to
the credits which expired by a certain date, Pioneer was not yet
tax positive and had not used the credits. He opined that
Pioneer would not see any benefit from those tax credits.
6:28:50 PM
REPRESENTATIVE TUCK directed attention to the graphs for
proposed HB 72, and asked if a transitional credit would enhance
the proposed bill.
MR. FOLEY said that Nuna was the only project on the horizon for
Pioneer, and that most of the expenditure would be during 2013 -
2016. He affirmed that capital credits would not make any
difference to Pioneer, unless they invested in another project.
6:29:58 PM
REPRESENTATIVE TARR surmised that this reflected investments
currently made under ACES, and influenced by the capital
credits.
MR. FOLEY replied that it was necessary to look at the whole
system. He agreed that the credits, under ACES, were very
attractive, but that the tax rate was very high. However,
Pioneer did not yet have a profit, and therefore was not yet a
taxpayer. He disclosed that currently they were most focused on
the credits; however, in the future, the tax rate would be more
important.
REPRESENTATIVE TARR referred to an earlier presentation which
indicated that tax credits were not influential in decision
making, as bottom line cash flow was the most important. She
asked if that was not as true for a small producer.
MR. FOLEY observed that there were two really important points:
the credits were important for Pioneer's project economics as
they reduced the capital expenditure and increased efficiency on
the investment, the discounted return on investment (DRI). The
credits reduced the necessary capital, and allowed funding for
other opportunities. These credits allowed Pioneer to do 20
percent more than without.
6:32:12 PM
CO-CHAIR FEIGE encouraged Mr. Foley to provide additional
written testimony and suggestions for improvement to the
proposed bill.
6:33:11 PM
KARA MORIARTY, Executive Director, Alaska Oil and Gas
Association (AOGA), declared that AOGA was the professional
trade association for the industry, and that the 15 member
companies accounted for the majority of oil and gas in Alaska.
She declared that her comments had been unanimously approved by
the member companies, and she paraphrased from the following
written statement:
The greatest and most urgent challenge facing Alaska
today is the decline of oil production from the North
Slope. And the greatest, most urgent issue facing this
Legislature is how you will address this problem.
For someone who is happy and content to see Alaska
continue along the path it is headed on, the answer to
this question is - do nothing; leave the present tax
system alone.
But most Alaskans would disagree that this is the
future they want. They hope for a robust industry on
the North Slope beyond their own lifetimes. They want
their children and grandchildren to have the benefits
from the oil industry that this generation of
Alaskans, and the one before, have enjoyed. They want
the good jobs that the industry offers to continue,
and they want industry to continue to support the
education and skills training that are needed to
qualify for many of those jobs. They want their
friends and neighbors who work for the industry to
stay here. They want all the volunteer community
services to continue that industry employees perform,
and that companies themselves do directly. The want
the activity and growth in the Alaskan economy that
industry stimulates to continue. And, of course, they
like the fact that industry pays for a great majority
of the costs of government and hope that this, too,
will continue.
The role of AOGA, and of individual companies doing
business here, is not to tell Alaska how much it ought
to collect from oil and gas, nor should that be our
role. Rather, we should tell you about how Alaska's
tax regime is affecting our businesses, about the
parts of the present tax laws that are not working as
intended, and about ways to improve the tax structure
to get more of the intended results. With that
knowledge, you can then make sound, informed decisions
about how much tax to collect, how to collect that
amount, and when to collect it.
For several years there has been a red herring in the
public discussion about oil taxes. This is the notion
that any change in tax structure that reduces tax
revenues below the projections in the Revenue Sources
Book is a "giveaway." This reflects an assumption
that those forecasted oil and gas taxes are somehow a
"given" - something like money already in the bank,
and all the State Treasury needs to do is wait for it
to be deposited into the State's account. The fact,
however, is that industry has to spend roughly $2
billion dollars each year just to slow the production
decline from what it would naturally be, in order even
to approach the level of production published in the
Revenue Sources Book. And just like any other
investment industry makes here, these production-
sustaining investments have to beat the competition
elsewhere for those investment dollars: they are both
not a "given."
Worse, the "tax giveaway" argument assumes the
production in the Revenue Sources Book is all that
will be produced. These critics factor in nothing for
any additional production and revenue resulting from a
tax reduction. Instead it looks only at the downside
and ignores the upside. The upside, though, is real.
If a tax reduction makes investments here more
competitive, companies will want to make more
investments here for that upside. And they will do so
even though they, like the State, lack the gift of
prophecy and cannot know beforehand exactly what the
upside will turn out to be for any particular
investment.
As you consider solutions to the momentous challenge
that production decline creates, it will be wise and
useful to identify the principles you want the tax
system to earn, and the specific goals you want it to
achieve. AOGA believes Governor Parnell's four "core
principles" offer an excellent cornerstone for this:
"First, tax reform must be fair to Alaskans."
"Second, it must encourage new production.
"Third, it must be simple, so that it restores balance
to the system."
"Fourth, it must be durable for the long term."
We believe a fifth such principle will be prudent as
well, because the challenge facing Alaska is not that
there are too many companies pursuing opportunities
they see here, but that there are too few. Alaska
should therefore avoid tax changes that artificially
create "winners" and "losers."
With respect to House Bill 72, there are four major
features in it that we wish to address, and the Bill
omits several others that we would like to draw your
attention to. The major features in the Bill are the
elimination of progressivity, changes to the present
system of tax credits, a "gross revenue exclusion" for
certain new production, and the timing for these
changes to occur. Here are our thoughts on them.
1. Repeal of Progressivity. AOGA endorses the
elimination of progressivity. First, progressivity
directly attacks and destroys one of the few strategic
advantages that Alaska has, which lies in its economic
remoteness. It costs $9.42 on average to ship a barrel
of oil from the North Slope to the West Coast,
according to the Fall 2012 Revenue Sources Book,
Appendix D- 1b. This means Alaska starts off with a
disadvantage of $9.42 a barrel against Outside
competition, so other parts of an Alaskan investment
must be pretty strong in order to overcome this
disadvantage. Otherwise they won't be made.
If oil prices turn out to be higher than what they
were projected to be in the investment analysis,
nearly 100 percent of each extra dollar in price flows
directly into the Gross Value at the Point of
production (GVPP) and then, after royalties and taxes,
flows straight into the investor's bottom line. This,
in turn, improves the economic performance of an
Alaskan investment relative to an equally competitive
one Outside, because the Alaskan baseline was $9.42-a-
barrel lower and an additional dollar in price is a
larger percentage of that baseline than for the
percentage for the Outside investment. This can be
particularly significant for potential investors who
are bullish on oil prices.
Currently, progressivity in conjunction with a 25
percent base tax will take half of each dollar from
higher prices when the West Coast price is $132.38
(using the Fall 2012 Source Book numbers) -a price
that has already been seen, although somewhat higher
than today's. So, even for investors who are bullish
on oil prices, progressivity destroys half of the one
strategic advantage that Alaska's economic remoteness
provides. And the more bullish they are, the more this
advantage is undone because they will see higher rates
for progressivity at those prices in their investment
analysis.
Second, progressivity brings extraordinary complexity
to the tax, not only in calculating what the tax is,
but also in analyzing what the amount of the
progressivity is for any particular item that affects
a taxpayer's Production Tax Value (PTV). This
complexity exists because the tax rate for
progressivity depends on the taxpayer's PTV per
barrel, and then the resulting rate is applied to the
very same PTV that set the rate. This circularity in
the tax calculation leads to bizarre effects. For
instance, simply the fact that oil prices fluctuate
during a year instead of remaining perfectly flat
increases the tax even though the average of the
fluctuating prices is the same as the flat price - and
the greater the fluctuation, the greater the tax from
progressivity becomes. There is no objective economic
or financial reason for the tax to go up; instead,
this occurs entirely because the progressivity
calculation is circular.
2. Tax Credits
In general, tax credits, whether they be for drilling
a well, building a facility to gather new oil or the
pipe to build a flowline, represent a direct reduction
in the amount that a potential investor puts at risk
by spending money on the equipment and facilities. It
is important to reinforce that there is no tax credit
liability for the State at all until an investor
invests here. So it costs nothing to offer the credit
until the investment is made here, and at that point
the tax credit has already succeeded in what it is
supposed to do - namely to attract investment dollars
here.
A. Repeal of the Qualified Capital Expenditure ("QCE")
Tax Credit.
Even while the elimination of progressivity would
improve the competitiveness of Alaskan investments
from the present ACES tax, the elimination of the QCE
Credit would claw back a big chunk of that money and
undo a significant part of that competitive
improvement. This is because the benefit of the QCE
Credit depends only on how much is invested here,
while the benefit from ending progressivity depends on
the price of oil relative to a producer's lease
expenditures. For every producer, there is a price
below which the lost QCE Credit would start to
outweigh the benefit from the end of progressivity,
and exactly where that crossover comes would depend on
factors that are specific to each individual producer,
such as how much oil it produces, where it sells the
oil, its costs to deliver it there, and its lease
expenditures.
AOGA fears the repeal of the QCE Credit is likely to
create "winners" and "losers" artificially among
producers, and we see no sound tax policy
justification for doing so.
B. Small-Producer and Exploration Credits. AOGA
endorses the proposal in HB 72 to extend the small-
producer tax credit under AS 43.55.024 from the
present sunset dates at the start or middle of 2016 to
2022 and encourages the same extension the exploration
tax credits under AS 43.55.025. The State had sound
policy reasons for creating these tax credits, and
those reasons are just as valid today as they were
then.
The purpose of the small-producer tax credit was to
attract new players to Alaska who might otherwise have
been deterred from coming here by its remoteness,
northern climate, and the resulting challenges of
higher-than-average costs and expenses. The success of
the credit in doing this is a fact that cannot be
denied. AOGA sees this success in its own membership
and in other companies that have come here and are
active. The importance of having a healthy contingent
of smaller producers comes from the facts, first, that
they often have a different perspective about the
opportunities around them, and second, that no company
or group of companies can have a monopoly on good
ideas and innovation. For both reasons, the continuing
and increasing presence of these smaller producers
strengthens and improves the Alaskan petroleum
industry. We know from testimony that the small
producer tax credit has made a material difference in
individual companies' decisions to do business and
invest in Alaska.
The purpose and justification for the exploration tax
credits under AS 43.55.025 are equally plain and
clear. Huge geographical swaths of this state remain
unexplored for oil and gas, or have been explored in
little more than a rudimentary way. If exploration is
to occur in a timely fashion so any resulting
production can be transported through existing
infrastructure, the exploration tax credits are a
direct way of bringing that exploration about and
these type of credits should be extended as well. Just
as with the QCE credits for capital investments, there
is no exploration tax credit without real money having
first been spent on exploration work that qualifies
for these tax credits.
C. Limiting the transferability of "carried-forward
annual loss" tax credits. We have some reservation
about the proposal in HB 72 to bar almost completely
the transferability of the current "carried-forward
annual loss" tax credits under AS 43.55.023(b). These
credits arise every year for any active explorer until
it finds something and finally has production that has
a tax to apply the credit against. At present
explorers can only realize immediate benefit from
these credits by selling them to other taxpayers or
cashing them in at the state Oil and Gas Tax Credit
Fund established in AS 43.55.028.
Such sales and cash-ins would stop for North Slope
explorers under the Bill, who instead would be able to
hold the credit for up to 10 years for possible use
against tax on their own production, assuming they
find something to produce. During this l0-year shelf-
life the unused credits would increase at an annual
rate of 15 percent, compounded annually. The same
would apply for a North Slope producer with a year
resulting in a "carried-forward annual loss."
The Bill's only exception to this ban would be for a
transfer made in conjunction with a sale or other
transfer of an "operating right, operating interest,
or working interest" in a lease or property the person
acquiring that interest could also acquire a
proportionate share of the lease-or-property's accrual
loss credits arising before that transaction.
To prevent taxpayers from deliberately hoarding these
credits instead of using them in order to get the 15
percent annual increase, the Bill would deny the l5
percent increase for each year when they could use
their credits but don't. We believe this would be an
effective deterrent against abuse that might otherwise
occur.
In general, if sales and transfers of these annual-
loss tax credits are to be limited at all, then the
limitations proposed in HB 72 would be a reasonable
way to do it. Our major concern of the proposal is
that the 1O-year shelf-life for using a credit is
unrealistically short. If all the stars, planets and
constellations are in just the right alignment, it
might be possible for an explorer to go from
exploration and discovery to production in just l0
years. But that is not the norm - particularly on the
North Slope, where the limitation on transferability
would apply. We think 15 years would be more in line
with actual experience.
The geographical limitations on where the tax credits
must arise in order still to be freely sold or
transferred may have unintended consequences, but
because of confidentiality considerations, they are
not appropriate matters to be discussed within a trade
association like AOGA. We must therefore leave this
for individual companies to address if there is a
problem.
Of course, without the l5 percent annual increase in
the unused credits, AOGA would oppose the ban on
transferability because it would destroy the
incentives which the credit is supposed to provide to
explorers.
3. Gross Revenue Exclusion. This is the most
innovative feature in HB 72, and our major substantive
concern is that it is too narrowly focused.
The Gross Revenue Exclusion (GRE) would, in
calculating the taxable Production Tax Value, exclude
20 percent of the Gross Value at the Point of
Production of what we'll call "non-legacy" production.
Bill Section 24 calls it production "from a lease or
property that does not contain land that was within a
unit on January l, 2003[,]" or if it does have land
that was in a unit before 2003, "the oil or gas is
produced from a participating area established
after... 2011 [that] does not contain a reservoir that
had previously been in a participating area
established before ... 2012."
What this means is, the fields that are likely to lose
out on getting any GRE under HB 72 are Prudhoe Bay,
Kuparuk, Lisburne, Milne Point, Endicott, Niakuk,
Point McIntyre, and Alpine; as well as the Prudhoe Bay
satellite fields Aurora, Borealis, Midnight Sun, North
Prudhoe Bay, Orion and Polaris and the Kuparuk
satellites Meltwater, NEWS, Tabasco, Tam and West Sak.
Econ One Research, Inc. made a presentation to this
committee just last Wednesday entitled Analysis of
Alaska Tax System, North Slope Investment and The
Administration's Proposal, HB 72. In Slide 6 of that
presentation Econ One showed oil and gas resources
described as "Economically Recoverable @ $90/bbl"
totaling 29.1 billion barrels of oil and barrel-
equivalents of gas. Of this total, the slide shows
that 10.4 billion are in ANWR and the National
Petroleum Reserve-Alaska, another 9.9 billion in the
Chukchi Sea Outer Continental Shelf 5.8 billion in the
Beaufort Sea OCS, and 3 billion in the central North
Slope where all the producing fields are that I just
named.
To us, the slide shows that more than half - 54
percent - of this 29.1 billion-barrel resource lies in
the federal OCS, outside Alaska's sea-ward boundary
and beyond its jurisdiction to tax. Current federal
law does not provide for any OCS revenue-sharing with
Alaska, and even though Alaska's Congressional
Delegation is trying to change that, for now the only
direct revenues that the State stands to see from OCS
production are property taxes on the in-state portion
of a pipeline linking the OCS fields to TAPS, and an
increase in North Slope wellhead values resulting from
the greater TAPS throughput.
Another 34 percent of the resource is in ANWR - which,
again, we hope the Delegation will be able to open up,
although even Ted Stevens was unable to achieve it
despite four decades of dedicated effort. Another 1.7
percent is in NPRA, which - if the Interior Department
gets its way - will have its best prospective acreage
turned into a bird sanctuary despite being a
"Petroleum Reserve".
So, of the 29.1 billion barrels of potential reserves
identified by Econ One, only the 3 billion in the
central North Slope has any potential to contribute
significantly to Alaska's economic well-being in the
near and mid-term future. In other words, of the 29.1
billion barrel resources, only a tenth of it is within
the State's power to do anything about. And of this 3
billion barrels, 2.5 billion or more stands to come
from Prudhoe Bay, Kuparuk and other legacy fields
already in production. The Governor's second "core
principle" for tax legislation is that "it must
encourage new production." But, in order to get
results from such encouragement, the tax legislation
must reflect the opportunities that Alaska has for
getting results. Maybe the present Gross Revenue
Exclusion in HB 72 can get results, in some small way.
But in terms of what it attempts to "encourage," it
leaves out at least 80 - 90 percent of the 3 billion-
barrel opportunity in the central North Slope that
Econ One has identified as "Economically Recoverable @
$90/bbl[.]"
AOGA is continuing to search for ways to adapt the
Gross Revenue Exclusion to include legacy fields in a
way that might be acceptable to the Administration and
the Legislature. It may turn out, however, that a
different approach may be necessary to "encourage new
production" in legacy fields.
For now, though, all we can say is, not enough is
being done in HB 72 to improve the economic
competitiveness of legacy fields, and for the coming
decade or so these legacy fields will be the "trunk"
that supports all the rest of the North Slope "tree."
Until there is significant production from the Arctic
OCS, the tree cannot survive very long without the
trunk production to keep per-barrel transportation
costs down and necessary infrastructure in place. It
would be a mistake to let that trunk wither.
4. Issues that HB 72 does not address. There are
several significant problems in the present ACES tax
that are not addressed in HB 72.
A. Minimum tax for North Slope production. AS
43.55.011(f) sets a minimum tax that is targeted
solely against North Slope production. That tax is
based on the gross value of that production instead of
the regular tax based on "net" Production Tax Value.
The rationale for adopting it was to protect the State
against low petroleum revenues when prices are low.
The minimum tax only complicates potential new
investors' analyses of what their tax would be if they
invest here instead of someplace else, and
consequently it has, if anything, driven investments
away. AS 43.55.011(f) should be repealed.
B. Statute of limitations & statutory interest. Here
we have two concerns that are interrelated, but not in
an immediately obvious way.
The statute of limitations under AS 43.55.075(a) is
six years from the date when the tax return was filed
for the tax being audited, while the limitations
period for other taxes under AS 43.05.260(a) is three
years from the filing date of the tax return. Under
both statutes, the period may be extended by mutual
consent of the taxpayer and the Department of Revenue
(DOR).
The statutory rate of interest under AS 43.05.225(l)
for tax underpayments is "five percentage points above
the annual rate charged member banks for advances by
the l2th Federal Reserve District as of the first day
of that calendar quarter, or at the annual rate of 11
percent, whichever is greater, compounded quarterly as
of the last day of that quarter[.]" Currently the
Federal Reserve rate is very low, so 11 percent APR is
the applicable rate.
Taxpayers are required under AS 43.55.020(a)(l)-(3) to
make monthly estimated tax payments for each calendar
month's taxable production during a year, but the
final tax amount for the entire year is reported on
March 31 of the following year under AS 43.55.030(a).
And AS 43.55.020(a)(4) requires any additional tax to
be paid at that time. The statutory interest under AS
43.05.225(l) starts to accrue on any underpayment from
that March 3l true-up date.
In practical terms, what these various statutes all
mean is this.
For each dollar of underpaid tax that the Department
of Revenue may claim after an audit, statutory
interest on that dollar at the end of three years
would be -
$1.00 x [(l +0.11/4)(4 compoundings per year times 3
years) - 1] = $1.00 x 1.38478 - 1] = $0.38.
After six years the statutory interest on the dollar
would be -
$1 00 x [(l + 0.11/4)(4 compoundings per year times 6
years) - l] = $1.00 x [l.91763 - 1] = - $0.92.
Thus, for each dollar of uncertainty there is in what
the taxpayer reports on its March 31st true-up for a
given year, there is about 38 cents of additional
uncertainty due to statutory interest under a three-
year statute of limitations, but 92 cents under a six-
year statute.
It is the combination of a six-year statute of
limitations plus a minimum statutory interest rate of
11 percent APR that is so harmful for a taxpayer and
any would-be investor. Each dollar of uncertainty in
the amount of tax will nearly be doubled by statutory
interest after six years.
When we speak about uncertainty and audit assessments
six years after the filing of tax returns, many people
will think the oil companies could calculate their
correct tax liability under the ACES tax if they
wanted to. Frankly, so did I before I got this job. So
let us take a few moments to illustrate why this is
not the case.
As amended by ACES, AS 43.55.150 (captioned
"Determination of gross value at the point of
production") says the Gross Value at the Point of
Production (GVPP) "is calculated using the actual
costs of transportation" from the field to market
unless the "shipper... is affiliated with the
transportation carrier[,]" or the "contract for the
transportation ... is not a[t] arm's length[,]" or the
"method or terms of [the] transportation ... are not
reasonable in view of existing alternative
transportation options." "If the department finds
that" any of these situations exists, then the GVPP
"is calculated using the actual costs ... or the
reasonable costs of [the] transportation ...,
whichever is lower."
The immediate questions about the statute are - How
does the Department of Revenue get the information to
make such a finding? What is the procedure for making
them; is there a hearing, an investigation or what?
How does a taxpayer ascertain what the Department has
found?
l5 AAC 55.193 is the regulation with an important part
of the Department's answers to these questions. Before
getting to those answers, we note that subsection (a)
seems to disregard the statutory distinction between
"actual" and reasonable" costs, by declaring that
"Costs of transportation are the ordinary and
necessary costs incurred to transport the oil or gas"
- which could get to the same result as the statutory
terms, but not necessarily.
Subsection (e) of the regulation starts answering our
questions. It says "a tariff rate ... adjudicated as
just and reasonable by the Regulatory Commission of
Alaska ... establishes the reasonable costs of the
pipeline transportation[.]" So, suppose there has been
full-blown tariff dispute before the Regulatory
Commission of Alaska, and the RCA has "adjudicated [a
tariff as just and reasonable[.]" And suppose also
that a producer ships its oil through its pipeline-
company affiliate and pays that RCA-approved tariff.
Is this "reasonable" cost under (e) of the regulation
the same as the "ordinary and necessary" cost for it
for purposes of subsection (a)? Apparently so, but the
inconsistent terms in the two subsections prevent this
from being completely clear. Moreover, if the
transportation occurs "later than five years after the
end of the test period on which the tariff rate is
based[,]" then even subsection (e) says the tariff
ceases to "establish [the] reasonable costs" for the
transportation. But it doesn't say what the right
tariff is after those five years are up, or even how
to find out or calculate what it is. It is utterly
silent.
The very next sentence in subsection (e) after the one
speaking about that five-year period starts, "If a
complaint challenging [a] tariff rate has been filed
with [the RCA] and accepted for investigation" - this
is not a situation involving an already "adjudicated"
tariff, but one that deals with a new tariff that has
been filed for RCA's approval, which is then
challenged. Here, too, the tariff on file is not
allowed as the transportation cost under (e) of the
regulation. Instead, the cost that is allowed is "103
percent of the costs of transportation calculated by
the department using the methodology under 15 AAC
55.197, for the period [while the complaint is being
heard and adjudicated by the RCA.]" Note that it is
the Department of Revenue, not the taxpayer that makes
the calculation under l5 AAC 55.197. It is impossible
for the taxpayer to know beforehand what the
Department's calculation will turn out to be.
Now it is true that 15 AAC 197(m) says a taxpayer may
each year "request in writing the department's
determination of the applicable after-tax rate of
return under (f) of this section [and t]he department
will provide the department's determination to the
producer no later than the later of July 1 of the
calendar year or 90 days after the department receives
the producer's request." But the "after-tax rate of
return" that the Department promises to provide is
only one of the parameters in the cost-based tariff
calculation under 15 AAC 55.197. The taxpayer is left
on its own to find the correct numbers for the other
parameters. More importantly, subsection (m) applies
only to "a producer [that] expects to produce oil or
gas the actual costs of transportation of which are
required by 15 AAC 55.193(b)(6)[.]" Section -
193(b)(6) applies only to "transportation of oil or
gas by a non-regulated pipeline facility ... that is
owned or effectively owned ... by the producer of
th[e] oil or gas[.]"In the situation I'm describing,
it is a regulated pipeline, not an unregulated one, so
this promise in 197(m) does not apply.
We find nothing else in the calculation-methodology
regulation, l5 AAC 55.197, nor in I 5 AAC 55.193(e),
the transportation-cost regulation, that commits the
Department to make the cost-based tariff calculation
called for in 193(e) and inform the producer of that
result before the producer has to report and pay
estimated tax each month, or before it makes its
annual true-up on March 31st of the following year.
The only deadline for informing the producer of the
Department's calculated tariff is the six years under
the statute of limitations.
And the same or very similar unknowable answers -
including tariff calculations by the Department under
15 AAC 55.197 - arise under 15 AAC 55.193 regarding
tariffs for new transportation facilities that are
just being placed in service, and under -193(g) - (h)
regarding tariffs set under a settlement agreement to
which the State of Alaska is a party.
And just to prevent any misunderstanding, although I
have been testifying about proceedings and
adjudications by the RCA, these regulations also apply
to proceedings and adjudications by some "other
regulatory agency" - which would include FERC.
There is a built-in uncertainty created by these
regulations, and others that is beyond a taxpayer's
allowed authority to answer and beyond its ability to
know before the Department gives the answer. And to
see a "Technicolor" version where essential elements
of the tax calculation are being reserved for the
Department to "determine" in its discretion with no
specific deadline, one should look at all the crucial
"determinations" in 15 AAC 55.173 ("Prevailing value
for gas") that are reserved for the Department to make
regarding the valuation of natural gas that would be
transported to markets outside Alaska.
We are not asking for a statutory fix to the
regulations. But we are asking that, if the Department
chooses to defer making calculations and similar
determinations that are necessary in order even to be
able to calculate the correct amount of tax at all,
then the doubling-up of that uncertainty through
statutory interest should be lessened - either by
shortening the period for making those
"determinations" from six years back to the usual
three, or by eliminating the 11 percent minimum
interest rate on the statutory interest rate, or both.
C. Joint-interest billings. Our concern about joint-
interest billings is also primarily a problem caused
by the approach the Department has chosen to take with
its tax regulations. Instead of starting with the
joint-interest billings that participants in a unit or
other joint operation receive from the operator, the
regulations reflect an assumption that each non-
operating participant has information, in addition to
the operator's billings to them, that allows them to
determine which expenditures are deductible as allowed
"lease expenditures" under AS 43.55.165 and which are
not. This assumption is wholly unrealistic. And even
if there were some merit to it, the regulations opt to
audit each participant separately regarding that
participant's interpretation of which expenditures are
deductible and which are not, instead of auditing the
system of accounts used by the operator and telling
all participants which cost items in that accounting
system are deductible and which are not. In other
words, instead of one audit of the expenses by a joint
venture for any given period, the Department audits
each participant separately for its respective share
of the same pool of expenses.
Again, we are not asking for legislation to put the
Department's regulations on a different track. But
there are some in the Department who believe that the
repeal by the 2007 ACES legislation of AS 43.55.165(c)
and (d) - which specifically authorized the Department
to rely on joint-interest billings - means the
Department cannot legally rely on them now. While we
disagree with this position (which is also at odds
with what the Department testified to during the
enactment of the 2007 ACES legislation), we do think
it would be appropriate to restore language
specifically authorizing the Department to rely on
joint-interest billings if it chooses to do so.
Conclusion. We support the proposed elimination of
progressivity, but we have concerns with what the Bill
proposes for tax credits - most importantly with the
proposed repeal of tax credits for qualified capital
expenditures. The trade-off between repealing
progressivity and losing the QCE credit is not a net
benefit for industry at low oil prices, although it
would be with prices that are high relative to costs.
The concept of the Gross Revenue Exclusion has
considerable potential, but its narrow focus in HB 72
misses 80 - 90 percent of the opportunity in the
central North Slope described by Econ One. We will
continue to work with you and the Administration to
find a fair and reasonable way to expand its scope, or
to find an alternative that will address the central
North Slope appropriately.
The reasons that led the State to create the small-
producer tax credit under AS 43.55.024 and the
exploration tax credits under AS 43.55.025 remain
valid today. We are pleased that HB 72 will extend the
sunset date for the small-producer tax credit and
encourage the same extension be applied to the
exploration tax credits.
Overall, the Bill as introduced represents a
cornerstone for significant and crucial tax reform
that move toward Governor Parnell's four "core
principles" - fairness for Alaskans, encouraging new
production, simplicity with balance, and durability
for the long term.
I have not mentioned, until now, the North Slope
decline curve that's on the slide I've showed at the
beginning, and now here at the end of this testimony.
I don't need to mention it. It's the elephant in the
room. As I said at the beginning, the greatest, and
most urgent challenge facing Alaska today is the
decline of oil production from the North Slope. We
believe it is up to you, the legislative leaders of
our time, and the Governor, to shape a competitive oil
fiscal policy that is supported by strong principles
and will lead Alaska towards a prosperous future for
the long-term. You have a difficult task ahead and
AOGA stands ready to assist you throughout this
process.
6:57:12 PM
REPRESENTATIVE TARR asked for a suggestion of balance between
the elimination of progressivity and the elimination of QCE
credits to encourage new investment in Alaska.
MS. MORIARTY replied that earlier testimony had indicated that
no producer in Alaska was the same; therefore, the challenge to
the legislature was to find the balance that did not create
winners and losers. She suggested that different types of
credits specifically geared toward well lease expenditures,
similar to Cook Inlet, could be re-established on the North
Slope. She stated that AOGA did not believe that elimination of
both progressivity and QCE would have a desired result.
6:59:41 PM
MR. ARMFIELD said that Brooks Range Petroleum would become a
member of AOGA once oil production had begun.
7:00:01 PM
REPRESENTATIVE SEATON, noting that some important considerations
for a company when making a decision for investment in a project
included net present value, internal rates of return, and cash
flow, pointed out that these had also been considered regarding
investment in Alaska during deliberation for PPT and ACES. He
stated that testimony had now declared that return on capital
was the most important aspect. He asked what metric was the
most important for Brooks Range Petroleum.
MR. ARMFIELD declared that the metrics were different for every
company, and that net present value and internal rate of return
were viewed for the project as a whole. He reported that the
key problem for Brooks Range was initiating enough cash to move
a project forward. He expressed the difficulty for marketing
this investment. In the current phase of development, capital
credits were the most important. Any change from ACES to
proposed HB 72 would impose the need to raise an additional $124
million to move the project forward in the next few years, and
he emphasized that cash up front was currently the most
important consideration. He stated that net present value and
internal rate of return were "end game" numbers, but capital
credits were necessary today.
7:03:38 PM
REPRESENTATIVE SEATON asked to clarify that the return of
capital invested was now the most important criteria, as he did
not remember that ever being a criteria during discussion for
PPT or ACES. He asked if the raising of capital was the most
important consideration for a small producer.
MR. ARMFIELD replied that this was correct, which he called cash
on cash, the cash invested to how many multiples it would
return. However, he emphasized that low internal rates of
return and net present values would keep the project from
progressing forward.
7:05:08 PM
REPRESENTATIVE SEATON surmised that progressivity was still
"quite a ways down the road where your company would be
concerned." He asked if investment attitudes and decisions
would change if the top 25 percent of progressivity was
eliminated, so it was capped at 50 percent.
MR. ARMFIELD expressed his agreement that any positive change
would instill confidence, yet he agreed with Mr. Foley that a
simpler overall structure was best for everyone in the oil
industry. He pointed out that it was still necessary to
convince investors about Alaska, and he declared the need for a
banner to attract investors with the certainty that the rules
would remain constant.
7:08:36 PM
REPRESENTATIVE SEATON asked if the proposed gross revenue
exclusion (GRE), which had a highly complex set of matrixes,
would have to be analyzed to figure the effect on the rest of
the project.
MR. ARMFIELD said that Brooks Range had not presented the GRE to
any investors; however, he opined that the 20 percent GRE was a
tradeoff for the QCE, as it deferred the contribution to a
production input base.
7:10:47 PM
REPRESENTATIVE SEATON reported that it was no longer tied to the
investment, as were the capital credits, but to the
profitability of the oil as it excluded a percentage of the
revenue generated for the duration of the project.
MR. ARMFIELD suggested that his understanding was for the 20
percent to include the capital budget, and that the only
reduction from the gross revenue exclusion was for the TAPS
throughput and the West Coast transportation. Then the 25
percent base tax was applied.
7:12:28 PM
REPRESENTATIVE SEATON agreed that it was complex, and he
questioned whether the GRE was making the system simpler. He
asked for any suggestions for improvement to the proposed bill.
MR. ARMFIELD agreed to get clarification, and he pointed out
that, as his two latest projects would not qualify for GRE, he
did not consider it as a benefit.
7:13:25 PM
[HB 72 was held over.]
| Document Name | Date/Time | Subjects |
|---|---|---|
| HRES HB 72 Bradford Keithley Comments.pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |
| HRES HB 72 -Keithley, Five things to look for in oil tax reform . (11.23.2012).pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |
| HRES HB72 Brooks Range Petr..pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |
| HRES HB 72 AOGA.pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |
| HRES HB 72 Pioneer Natural Resources.pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |
| HRES HB 72 AOGA Written Testimony 2.18.13.pdf |
HRES 2/18/2013 1:00:00 PM |
HB 72 |