Legislature(2017 - 2018)HOUSE FINANCE 519
03/23/2017 01:30 PM House FINANCE
Note: the audio ![]()
and video ![]()
recordings are distinct records and are obtained from different sources. As such there may be key differences between the two. The audio recordings are captured by our records offices as the official record of the meeting and will have more accurate timestamps. Use the icons to switch between them.
| Audio | Topic |
|---|---|
| Start | |
| HB111 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 111 | TELECONFERENCED | |
| + | TELECONFERENCED |
HOUSE BILL NO. 111
"An Act relating to the oil and gas production tax,
tax payments, and credits; relating to interest
applicable to delinquent oil and gas production tax;
and providing for an effective date."
1:34:33 PM
RICH RUGGIERO, CONSULTANT, CASTLE GAP ADVISORS, LLC,
introduced himself.
CHRISTINA RUGGIERO, CONSULTANT, CASTLE GAP ADVISORS, LLC,
introduced herself.
Mr. Ruggiero provided a PowerPoint presentation titled
"Petroleum Fiscal Design HB 111" dated March 23, 2017 (copy
on file). He addressed slide 2 and reviewed the
presentation agenda. He intended to address his
professional background, oil patch stage setting concepts
pertaining to fiscal taxation, and to provide time for
questions. He planned to address interactive Castle Gap
models the following day. He shared that he had 40 years of
energy industry experience. He characterized his experience
as a three-legged stool. He had two decades with big oil -
running operations and commercial and big projects. He had
spent a decade helping to run a consultancy and had
primarily provided sovereign advice for governments around
the world. He continued that the consultancy had been
purchased and he had then served as an executive at a
service company.
Mr. Ruggiero reported that he had gained a new perspective
on the business while working for the service company. He
referenced that the state was dealing with credits. He
relayed that the service company had gotten involved
because it was an unpaid creditor in a couple of company
bankruptcies in Alaska. The big issue was where the credits
went - to the companies' financier or the trade - when the
companies got paid the credits. Most of the credits had not
gone to the trade.
Mr. Ruggiero addressed his fiscal background. He shared he
had been involved with designing or redesigning petroleum
fiscal systems for multiple countries (including
legislation, regulation, and associated contracts involving
license rounds (seismic) to get maximum value for the
government). He had worked with new emerging countries
including East Timor in 2002 - at the time the country had
no prior energy development or experience. Additionally, he
had worked on foreign company re-entry for Saudi Arabia and
Kuwait - two of the more sophisticated players in the
business. He noted that working with a wide variety of
clientele required a broad toolbox. As an operator he had
spent substantial time testifying to bodies like the House
Finance Committee with respect to competition, opening of
markets, and fair third-party access to pipelines in the
U.S. and Europe.
1:39:46 PM
Mr. Ruggiero continued that he had been on both sides
(governments and companies) of the table negotiating large
contracts. He briefly highlighted slides 5 and 6. Slide 6
showed a range of consulting clients he had worked with and
the associated scope of work provided. He turned to slide 7
and discussed his current role in Alaska. He had been hired
by Legislative Budget and Audit (LB&A) to help the
legislature make needed decisions, to analyze proposed oil
and gas legislation (HB 111), and to provide advice and
recommendations. He credited the House Resources Committee
for allowing him to share what he did and did not believe
in. He noted that based on a variety of reasons valid to
the legislature, many times legislators did not agree with
his recommendations, which was fine. Based on what the
legislature decided, his job was to highlight potential
pros and cons for consideration when forming legislation.
He did not advocate for one side or the other; he was
merely bringing experience to the table for the legislature
to consider.
1:41:59 PM
Representative Wilson appreciated Mr. Ruggiero's analysis
on HB 111 and she asked if he had spent time analyzing SB
21 and other to determine how it had met the state's goals
and how HB 111 may or may not fit into proposed changes.
Mr. Ruggiero answered that he had worked extensively on
Alaska's Clear and Equitable Share (ACES), which had
required reading and understanding the Petroleum Production
Tax (PPT) and the Economic Limit Factor (ELF) tax systems.
Following those systems there had been work putting in a
step progressivity instead of continuous, which he had been
involved with. He spoke to the Alaska Gasline Inducement
Act (AGIA) and the gas line discussion and relayed he had
missed SB 21, but he had reviewed much of the work on SB 21
and HB 247 [from the prior year].
1:43:26 PM
Co-Chair Seaton noted Representative Jennifer Johnston was
in the audience.
Mr. Ruggiero moved to slide 9 and addressed how he saw
Alaska's priorities. He detailed there were long-term
drivers and short-term drivers that needed to be balanced.
Long-term drivers included gas for Southcentral (for
heating, industry, and utility), more from legacy fields,
and the development of new big North Slope fields. In
recent years there had been testimony that with the right
investment and incentives there was several billion barrels
remaining in legacy oil fields. He stated that the long-
term drivers were balanced against the state's financial
shortfall. Alaska was a government with high dependency on
oil-based revenues.
Mr. Ruggiero addressed his recommendations on slide 10. He
had presented a model in the House Resources Committee
showing a stepped total net system, which would make it
possible to eliminate 90 percent of the gas taxation
language in the current legislation; it would deliver the
same results in terms of the net tax paid by a player at
given price at a given production tax value (PTV). He
furthered that removing all the different levels would
simplify and would remove many of the issues involving
audits and the time it took to get things done.
Simplification would make it easier for everyone to model
and understand whether they wanted to invest in Alaska and
by how much.
Mr. Ruggiero discussed simplification of the multitude of
special terms in the current legislation. He listed terms
including special Cook Inlet, Middle Earth, and oil versus
gas in-state versus gas going out-of-state. He remarked
that the distinctions had been included because the
legislation had relative values, or it had been discussed
that something remaining in-state may have more or less in
value than something going out-of-state. If the state had a
system based on unit profit, it was not necessary to
include all the different exceptions or conditions in the
legislation.
Mr. Ruggiero addressed that to achieve the state's desired
objectives (much more oil on the North Slope that would
continue to keep the Trans-Alaska Pipeline System (TAPS)
above its minimum operating limit), oil companies should be
allowed to recover 100 percent of their costs and net
operating losses (NOLs). He remarked he had been quoted as
saying it would move the state to the bottom of the
rankings if it did not allow the cost recovery. He
confirmed his belief that it would move the state close to
the bottom of the list of comparative systems.
1:47:30 PM
Mr. Ruggiero clarified that in most tax and royalty
systems, costs became a deduction, much like interest on a
home mortgage. It was possible to deduct the amount paid
and it saved a company from paying tax on the amount. For
example, if someone was in a 25 percent bracket and had
$1,000 of mortgage interest, the deduction would save the
person $250 in tax. In production sharing contracts it was
a full recovery of the amount, not a deduction. In a
production sharing contract, if there was $1,000 in cost,
the entity could recover the $1,000 of income before any
tax was assessed. He relayed it was the reason there was
substantial investment in countries with marginal tax rates
greater than Alaska - the countries allowed full recovery.
He explained that options included full recovery, partial
deduction, and no deduction. It took an entity from the top
of class to the bottom of class.
Mr. Ruggiero explained that every regime he had worked in
either allowed companies to deduct or recover all the costs
spent on developing the oil and gas. He recommended
eliminating all cashable credits except for the failed
explorers. If the state was giving companies incentives to
invest in Alaska, the incentive was to get to development
and get into production. By making it deductible only
against the income from produced barrels, it provided
motivation to get production underway as soon as possible.
1:49:58 PM
Representative Ortiz observed the option recommended on
slide 10 was clear and would be simpler for everyone. He
wondered what would prevent the state from simply choosing
that route.
Mr. Ruggiero responded that there was not always the will
of the two legislative bodies to make something happen. The
issue came down to what there was support for and what the
legislature could get done. He stated that like every
system he had worked with, at any point in time it was a
combination of what had all been good decisions at the time
they had been made. After being out of Alaska for about
four or five years, he had not seen it for the individual
things he had helped work on, but as a whole. He stated
that the whole looked very messy and confusing. He referred
to various items in the bill including per barrel credits,
the gross value reduction (GVR), the hard floor or soft
floor, and other. He had observed there had to be a simpler
way. If there was the legislative will to do it and the
time to do it in, there was a solution that eliminated many
of the little "one offs."
Mr. Ruggiero provided scenario where there were two items
in HB 111 and the legislature could elect to do option A
but not option B; however, option B had been based on
moving forward with both options. Therefore, it became
necessary to go back to fix option A to ensure it accounted
for the fact that option B had not been included. He used
the carnival game "whack-a-mole" as an example - every time
one issue was solved, two more popped up. He explained that
was what took place with a system with so many moving
parts.
1:52:28 PM
Representative Guttenberg stated that some people tried to
convince legislators that every decision it made on a
project, tax base, or other, would determine the entire
outcome of a company's project down the road. Over the
years he had heard that it was just one factor when people
went into the board room to try to sell a project. He spoke
about high prices, need for production, the economy, and
Alaska's own set of variables. He asked about important
factors for organizations making decisions on whether to
invest in a location.
Mr. Ruggiero shared his personal experience taking large
projects to the board of a company had had worked for in
the past. He explained that the tax system was one
component. But there were also various associated risks
that the company would consider how to mitigate. In some
regimes or locations it was very difficult or not possible
to mitigate certain things. The company would also
determine how the investment fit into the diversification
of its desired portfolio. Many companies published their
target of investment in long-term projects, short-term
projects, and midstream or downstream projects. There was
never just one factor, it was a combination of factors. He
referred to the fable the Princess and the Pea. He detailed
that certain things had bothered a management team to the
point where very good projects had not been done because of
that one little "pea under the mattress." He could not
specify what the issue would be for any company; however,
there would be certain things that merely bothered a
management team looking to make the decision to invest or
not.
Representative Grenn asked Mr. Ruggiero to address where
the bill put Alaska on the competitive spectrum and how the
state compared to other locations.
1:55:58 PM
Mr. Ruggiero answered the presentation contained a section
related to the traditional comparative studies that were
done.
Vice-Chair Gara stated he would be amenable to rewriting
the law along the lines Mr. Ruggiero had addressed earlier
in the meeting. However, he recognized the legislative
reality that it was possible to make some changes that fit
within people's willingness and some that did not. He
assumed it would not be possible to do a new rewrite that
increased the tax rate based on company profitability.
Currently oil prices were low, and he was not interested in
making big tax changes when companies were operating in the
red. He asked how Mr. Ruggiero would view a proxy that
raised the gross tax rate slightly at price points as
company profitability increased. He noted that according to
the Department of Revenue (DOR), the average field was
profitable at about $41 to $42 per barrel on the North
Slope. The tax rate would be 5 [percent] at $50, 6
[percent] at $56, and 7 [percent] at $62 - it would let
companies take in extra money, but would give the state a
share at the low prices.
Mr. Ruggiero replied that the first question that needed
answering was whether they were talking about the hard
floor. He referred to Vice-Chair Gara's suggestion of going
from 4 to 5 [percent] at a price point and from 5 to 6
[percent] at a price point. He stated that 1 percent
increments would be a 20 to 25 percent growth in the
minimum tax, but when compared to a company's cost
structure, the percentage would be around 1 percent of the
company's operating cost, which was not that big. If the
conversation was merely about the increment it was one
thing, but if the conversation was about hardening the
floor and raising the tax, it became a fairly large number.
Individual projects would impact them differently. For
example, a larger project with a low unit cost and a
relatively low tariff would not be significantly impacted
because the net tax would be greater than the gross
minimum. Alternatively, new or high-cost fields would
probably be impacted much more significantly. The change
would be much more onerous to companies at the high end of
the cost spectrum.
1:59:12 PM
Vice-Chair Gara spoke to the three percentage points for a
high-cost field, which could be eligible for royalty
relief. He wondered how it would impact the analysis.
Mr. Ruggiero answered that if the legislature decided to
increase the gross minimum, fields that were adversely
impacted would have the ability to apply for royalty
relief. Raising the tax by up to three points was the same
as raising the company's royalty by that much. If the
increase was enough to extremely and adversely impact the
economics of an operator, they could always apply for
royalty relief with the Department of Natural Resources
(DNR). That way, instead of trying to pick and choose
language to fit everyone in the state, it would be possible
to pick and choose what the legislature chose to vote on
and pass forward; if there was an outlier that was impacted
they could apply for relief under royalty relief.
2:00:38 PM
Representative Wilson asked if all fields were profitable
at prices of $42 per barrel. She noted that each field was
different and had different oil. She asked if it was
possible to specify that a certain price would always be
profitable.
Mr. Ruggiero answered that all fields were profitable at an
oil price of $200 per barrel; however, at a $42 price, he
had no idea which fields were profitable and which were
not.
Mr. Ruggiero moved to slide 12 titled "Philosophy of Fiscal
Design." The slide included a chart showing a breakdown,
split 1 and split 2. The gray bar on the left showed the
various components that went into the determination of what
each player in the system got - it began with the
exploration and finding costs and moved up through
operations and cost of capital. The gray bar included the
various components that nonproducer entities took such as
royalty, corporate taxes, petroleum taxes, and other. He
pointed to "split 1" and explained that everything below
the red line pertained to producers (shown in blue) and
everything above pertained to nonproducers (shown in
green). The bar also included a piece pertaining to the
return on capital. He noted that what constituted a fair
return on capital was subject to a spectrum of differing
views. He pointed to "split 2" and specified that the
yellow portion represented the recovery of cost, the
remainder was the profit oil (shown in red); there was a
split on profit. The profit oil was generally more on the
nonproducer side versus the producer side, which was
reflective of almost every jurisdiction worldwide.
Mr. Ruggiero relayed that the internal capital was
sometimes called the internal rate of return (IRR). He
advanced to slide 13 and addressed what constituted a fair
split of profit from the perspective of a company. He
explained it was necessary for a company to get back what
it spent on a project. There were generally extras that
went into the consideration of the desired IRR. Factors
included the location or situational risk (e.g. whether
there were hostilities staff had to deal with, if it was a
country that was easy to get goods into and out of, and
other). Certain companies would have risk premiums for
different locales of the world. Another factor was
exploration success. He remarked that producers had to
account for the fact that it may have taken three or four
exploration plays to be successful; the dry hole costs had
to be paid for somewhere. The company had to generate the
capital to continue to explore. Additionally, there were
research and development costs for new technology. He noted
that over half the oil currently produced in the Lower 48
was due to technology that did not exist in 2000.
Mr. Ruggiero stated that one of the biggest factors was
what constituted a non-allowed expense. He specified that
the idea that expenses could either be deducted or
recovered was not universal; different regimes put
different limits on what constituted a recoverable expense.
He elaborated that in some places the exploration counted
and in other places only development counted; and some
places allowed writing off abandonment and carry back
costs, while other places did not. He spoke about the break
between direct and indirect costs (what was out in the
field versus what may be in an office). All those
components were factored into what an oil company estimated
a fair IRR to be; it was necessary to make enough to keep
growing and be profitable.
Mr. Ruggiero relayed that companies he had worked with that
were new to energy wanted the money right away and wanted
to put people to work. He continued it really did not
matter if the company was merely running the food
concession outside the workplace - it was something and it
was more than the company had at present. Those companies
generally approached the workings of their fiscal system
with that type of concept in mind. More experienced
companies were focused on how to maintain constant work -
continued rigs running and fields under development.
Periods of high activity and low activity were not good for
economies. More experienced companies also became more
interested in multigenerational wealth and growth. Local
content had migrated to local ownership - in many countries
instead of the requirement for 10 percent to be spent with
local companies, it had become required to have a 10
percent local company as a partner.
2:07:48 PM
Mr. Ruggiero continued to address slide 13. He referred to
his prior example of a company running a food vendor
outside the workplace - it had been a LNG Trinidad project
he had been involved with as part of Amoco. At present,
Trinidad had advanced as a country that built offshore
platforms. In the past the company had been worried it
would not find enough tradespeople to meet the local
content rules. As governments found themselves on different
spots on the spectrum, the idea of what constituted a fair
return for the company and the government changed.
Mr. Ruggiero addressed slide 14 titled "The 100,000 Foot
Overview" pertaining to the oil business worldwide. The
only constant in the oil patch was change. He shared he was
in the fifth down cycle of his career in the oil patch. He
explained that the industry changed based on the price of
its commodity and the amount of work occurring at any given
time. He explained that downturns were good because changes
in technology occurred during those times, which had
allowed the oil patch to emerge and grow out of the
downturn even during low prices. There would be times of
low and high prices in the future. He urged the committee
to not tie anything to one specific view of what the future
would be. He guaranteed the idea would be wrong. Change did
not necessarily mean instability, but change in the wrong
direction did. He addressed the right versus the wrong
direction. He believed the legislature had heard from
companies about what currently constituted the wrong
direction. As a government, he believed the state needed to
decide on its needs as well and what sort of change it
wanted. He stated that fiscal systems built for predicted
future outcomes failed sooner or later. Alternatively, it
led to situations that were not intended or considered,
which could result in someone getting too little or too
much, meaning adjustments were necessary.
Mr. Ruggiero continued that the new trend and his
recommendation was that something based on net unit
profitability could be self-correcting. Wherever triggers
were set could be set to self-correct so when profits went
lower the system would correct one way and if profits went
high it would correct another way. If the terms were set
accurately, it would provide a durable long-term system
that could accomplish the desired outcomes. He cautioned a
myopic view related to the present problem, which could put
future long-term goals at risk. He underscored finding the
right balance.
2:12:21 PM
Mr. Ruggiero advanced to slide 15 and provided a DOR table
as an example of Alaska change. He noted the table had been
provided by DOR to the House Resources Committee. The table
included data for 2007 to 2016 and the per barrel costs
were highlighted in red, which had gone from $17 up to over
$40 and back down as costs had come down. To the right of
the table he had added when various oil legislation had
passed. During the time of Alaska's Clear and Equitable
Share (ACES) and PPT, people had said that at $30 per
barrel progressivity started, but he noted it was not
accurate. He elaborated that ACES had been based on profit
per barrel, not price. All the thinking and work that had
followed in subsequent sessions and bills treated things a
bit differently. Things were run based on the assumed
profitability at a point in time and price, but as the cost
structures went up and down, profitability changed at that
price. For example, if in 2007 oil prices had been $60 per
barrel with almost $40 in profit, the $60 per barrel in
2015 only had $20 in profit per barrel. There were very
different situations when firm taxes were set at a price
instead of profitability. One thing that may make sense at
a $40 profit did not make the same sense when making $20
profit at a $60 price of oil. He stressed the importance of
ensuring underlying parameters and assumptions could move
when setting a mechanism based on a set of circumstances.
2:14:52 PM
Vice-Chair Gara addressed that not all fields were the same
- not every field on the North Slope was profitable at an
oil price of $41 per barrel (some were profitable at lower
prices, while others were profitable at higher prices). He
noted that $41 had been DOR's average estimate. He spoke to
royalty relief in Alaska - not all fields were the same and
outlier fields could see their royalty reduced. He asked
how much the state could reduce a company's royalty and how
effective it may be. He surmised that the tax had to be
somewhat the same for fields, but royalty relief provided a
relief mechanism. He asked for detail.
Mr. Ruggiero understood that the state had royalty ranging
from 12-plus percent to 16-plus percent. New fields could
get relief down to 5 percent - 7 to 11 percent royalty
relief could be granted. He noted it was the same as saying
7 to 11 percent gross tax. He believed mature fields were
allowed to go down to 3 percent. He noted that many things
presented to the legislature always used averages. Looking
at the average did not consider the two extremes on either
end and whether the standard deviation was small or large.
He stated that building to averages became a problem, but
as a legislature that was all it had; therefore, terms were
built on averages. If terms did not work for an operator,
it had the ability to apply for royalty relief.
Vice-Chair Gara believed it allowed for developing a tax
system a government believed was fair and if the system
overshot on one field, a company was able get 7 to 13
percent royalty relief. He asked about the accuracy of his
statements.
Mr. Ruggiero replied it sounded right.
2:17:56 PM
Representative Wilson remarked on varying prices over the
years and how some fields had peaked and gone down and
others were peaking at present. She observed they were
trying to have a one-size-fits-all tax regime. When it did
not fit all, the state tried options like royalty relief
and tax credit incentives. She thought the bigger picture
was trying to fix a tax regime. She believed the issue was
that one size did not fit all. She referred to slide 15 and
noted that the table showed the barrels but not the price
or what fields tried to come online and what their costs
were compared to legacy fields. She asked what specifically
the committee should glean from the table.
Mr. Ruggiero made clarifying remarks about the table on
slide 15. He wanted members to take away that if a regime
chose to set a mechanism in its petroleum fiscal policy at
$80 per barrel - at the time the amount was set the
government had a view of what $80 per barrel represented
(i.e. an amount of profit or activity) - three or four
years down the road most of the original assumptions no
longer held at a price of $80 per barrel. He furthered that
assumptions may hold at $98 or $110 per barrel instead.
However, legislation tied to a specific price as opposed to
the concept the state was trying to achieve meant that the
legislation did not move with changes in the industry. He
continued that costs would change, unit profitability would
change, different fields would be discovered. He used a
potential unconventional development by Great Bear compared
to a standard development by ConocoPhillips or Caelus. He
stated it was the things that were not considered at the
time something was fixed at a price. He recommended against
fixing on a price, but fixing on a concept like unit
profitability where regardless when underlying parameters
changed, whether $10 per barrel was made at an oil price of
$100 per barrel or $10 per barrel at an oil price of $40,
the profit was still $10 per barrel.
Representative Wilson believed trying to fix an issue
because of a fiscal gap was the wrong reason to change the
oil tax structure compared to what was best for the
industry at the time.
Mr. Ruggiero believed it was necessary to consider whether
the current system was good for the industry - the industry
may say the current system was fine and should not be
changed. He thought it was also necessary to consider that
things at present were very different than they had been
when the existing parameters had been set, which brought
different results than anticipated. He believed that was
the reason for the legislation.
Representative Wilson asked if the legislation would have
been introduced if the state was not in the current fiscal
situation.
2:22:00 PM
Mr. Ruggiero replied that he had no idea.
Representative Wilson believed she knew the answer.
Mr. Ruggiero turned to slide 16 related to fiscal design
takeaways. He relayed there was no ideal structure for
taxing oil and gas - if there was the legislature would not
have to continue to address the issue and he would be out
of a job. Every tax regime was unique because a country
always tweaked general concepts to meet its needs. There
were certain durable tools that tended to work well and
other things that came and went. He shared that he had
recently advised a client against doing several things
because other countries had tried them, and they had been
unsuccessful; it was possible to benefit from the mistakes
of others. He reiterated that countries all had different
internal drivers and reasons for doing something a
particular way.
Mr. Ruggiero continued that regimes generally tried to
provide as much balance as possible between existing and
new players. New players always brought fresh thinking and
were positive for incumbents. Regimes also tried to provide
the right incentives to encourage new production and
additional production from existing fields. Early on, some
conventional fields may have only produced 20 to 25 percent
of the oil in place before the company moved on and left
the remainder for someone else; some of those fields -
through new techniques and technology - were currently over
60 percent recovery of the oil in place.
Mr. Ruggiero addressed the last bullet point on slide 16
and relayed that every system would create some biases. He
detailed that companies would optimize their operations
within those biases to maximize their profits. He noted
that people [law makers] may react to companies' actions by
saying "look what they're doing to me." He clarified that
the companies were not doing anything to the state - the
state gave them a law and they were getting the best
benefit for their shareholders within the law. He had done
the same thing as an operator; his job had been to maximize
the returns for the company within a country's legal
structure.
2:25:50 PM
Representative Pruitt appreciated the point. He believed
there was the idea that the system would be fixed; however,
no matter what was done, there would always be different
ways to analyze things and a different way that a company
would use the current structure to - do what it was
supposed to do - bring a benefit to shareholders. He stated
that legislators needed to remind themselves that as
Alaskans they were shareholders. There was a substantial
amount invested in the various companies through the
Permanent Fund. There would always seem like there were
loopholes even if they were not glaring. He stated it was
the way to handle it with a very complex tax structure like
a net structure with the various other incentives the state
wanted to bring to balance. He asked for the accuracy of
his understanding.
Mr. Ruggiero responded that Representative Pruitt was not
wrong. He referred to his past personal objectives or the
objectives of the company he had worked for and relayed
that employees had asked why they had elected option A
versus option B when they had been identical. He answered
that option A had fit his bonus and option B had not. He
referenced the term "punish by reward" and explained that
everyone would work to optimize within whatever system was
implemented. States built systems around the objectives
they had and that they were trying to accomplish. The
takeaway was the state would do some design based on things
that were important for Alaska, which would create some
biases in the system. He hoped to help the legislature by
identifying biases were that were being created in whatever
option it elected and whether the results were something
the legislature could live with or to determine if an
additional change was necessary.
2:28:30 PM
Mr. Ruggiero advanced to slide 17 and addressed why
companies invested in high take regimes.
Great Rock
· Size of potential reservoirs and projects
· Economies of scale
· Degree of control
· Project Management
Shape of the production curve
· i.e. slow declines, long life
"Durable" terms
Incentives that mitigate or minimize largest risks
Mr. Ruggiero elaborated on slide 17. He explained that
countries with good rock charged more than countries with
bad rock. He continued that generally good reservoirs led
to larger size project. Another factor was degree of
control - how much of the world the oil company controlled
versus how much a government agency controlled in project
development and day-to-day operations. The ability to bring
skill sets and manage large and complex projects to get
maximum value was important. Good rock also led to the
shape of the production curve. He stated that shale was
"hot," but in the five or six shale bases in the U.S., in
the first 18 months anywhere from 60 to 80 percent of the
total hydrocarbon was recovered. Whereas, reservoirs in
countries with high government take may last for 40 or 50
years - many fields found decades ago had been producing
that long or longer.
Mr. Ruggiero addressed durable terms on slide 17. Many
investments were under contract, which made them more
durable. There were also places where the regime had
changed frequently, but as long as companies received
better terms when prices were low and took more when prices
were high, the system was durable and a bit predictable to
the industry. The things that were not visible were the
number of different incentives that helped mitigate or
minimize the largest risks of the project.
2:30:59 PM
Vice-Chair Gara referred to high take regimes. He
understood that at high prices North Dakota was not
considered a high take regime, but they were considered
high take at current prices. He relayed that ConocoPhillips
had testified the previous day that it was still investing
in North Dakota. He wondered how North Dakota's tax related
to Alaska's at the current price regime. He referred to a
Conoco report on profits - Conoco was the only company
investing in Alaska that reported its Alaska profits. The
committee had been told the previous day that Conoco earned
roughly a quarter-billion dollars in Alaska in the fourth
quarter the previous year and had not done as well in other
locations (it had lost money in the Lower 48 and Canada).
He asked if that said anything about Alaska in terms of
competitiveness and why the company be investing in places
it was losing a large amount of money. He believed that
with low oil prices in 2015 that Conoco had lost $2 billion
in the Lower 48.
Mr. Ruggiero addressed the question about North Dakota
first. He knew there had been substantial discussion of
comparing Alaska to several of the Lower 48 states. The
reality is that all projects compete against each other for
capital. He explained that companies broke up their capital
into strategic buckets. One of the buckets for many
companies included high-dollar, high-reserve, high-
production, long-life fields with long lead times, which
was the category Alaska fell within. There were also quick-
in, quick-out, quick-profit fields onshore in the Lower 48.
He did not believe that overall the onshore Lower 48 fields
competed significantly with Alaska because they were
different buckets of capital. He continued that the
investments in Alaska compared to the Lower 48 were very
different worlds - worlds that both needed to exist for
companies to have diverse portfolios. The diversity enabled
companies to live through the highs and lows of the
business.
Mr. Ruggiero continued to speak to North Dakota and
specified there was a difference between legacy and new
leases. He estimated the royalty on legacy leases was
probably one-eighth or 12.5 percent royalty just like
Alaska. On top of that companies paid 10 percent - an ad
valorem and extraction tax with a trigger to add another
0.5 or 1 point. He estimated the gross tax would be
approximately 22 percent in North Dakota. Gross taxes were
regressive at low prices - the share of the oil prices paid
in taxes went way up or became infinite when costs exceed
"what you're getting out there" and it went down as prices
went up.
Mr. Ruggiero stated that at present there were people
paying as much as $12,000 to $15,000 an acre. He considered
160 spacing on Bakken wells to the Middle Forks formation,
which added about $2 million to each 160-acre section. He
added the $2 million to a $7 million well - a total
investment of $9 million. He continued that generally about
400,000 barrels of economically recoverable reserves were
generated - at $40 per barrel, the revenue was $16 million.
He factored in the royalty and severance taxes and noted it
became difficult to make money. He noted that new royalties
were typically in the range of 20-plus percent for new
acreage. He combined the 20-plus percent royalty, a 10
percent severance (extraction and ad valorem tax), and an
acreage acquisition charge became expensive. When comparing
two tax regimes it was important to include all the same
items for each system. He added that in a few slides he
would discuss a comparison that did not include all the
items needed to compare to regimes.
2:37:15 PM
Mr. Ruggiero addressed the second portion of the question
related to the profitability of ConocoPhillips. He remarked
that because Conoco reported Alaska separately, it was
possible to see that the company had been profitable in
Alaska. A Conoco representative had referenced the
company's analyst presentation the previous day, which
included two slides specific to Alaska. One of the slides
showed that in an all-in, all-inclusive basis, the company
could make money for a 10 percent return at an oil price of
$40 per barrel at present because the company had been able
to reduce its cost by 40 percent in Alaska. He guessed the
company had been losing money terribly 1.5 years back at a
$40 oil price. Due to reduced costs, the company was now
able to weather the storm in a lower price environment. He
stated the shift had come with substantial work by the
company and its employees.
Mr. Ruggiero moved to slide 18 and addressed that standard
regime comparisons were not necessarily predictors of
producer investment activity. He shared that he was not a
believer in any charts that purportedly ran economics,
because of having to really understand what went into each
of the curves. He used the chart by Daniel Johnston as an
example to show that although things looked great in one
spot and bad in another, where activity was taking place
was much different than the graph may imply. The chart
related to marginal dollars. He considered the government
take under a profit mode scenario with $1 more in revenue.
The scale on the graph was lower on the right and increased
to be higher on the left. The implication was that
everything up to the right was good because it showed a low
take, while everything to the bottom and left was bad
because it reflected high take. The arrows on the graph
indicated where things were in 1997, while the box and
arrow showed 2007. The graph included 2017 and provided a
10 to 10 to 10-year comparison. The graph also implied that
the companies on the top portion would receive all the
investment because they had very low government take,
meaning most of the money would go into the producer
pocket. However, that was not the issue. He spoke about
where the industry invested.
2:41:01 PM
Mr. Ruggiero advanced to slide 19 titled "Regimes with
Government Take Lower than Alaska." The slide excluded
locations that appeared under Alaska in the graph on slide
18. Alaska was plotted at approximately 62.5 percent, which
was the ACES marginal rate. Countries where large oil
companies were investing were highlighted with a red box.
Large companies included the three on the North Slope
[ExxonMobil, BP, and ConocoPhillips] and about 15 other
companies. He highlighted several locations with lower
government take than Alaska.
2:41:51 PM
Vice-Chair Gara asked if the chart was older (from the ACES
regime) or reflective of the current year.
Mr. Ruggiero responded that the chart was from Daniel
Johnston and presented where things stood in 2007. He used
Colombia as an example and explained government take was
about 48 percent in 2007, whereas in 1997 it had been above
70 percent. The chart reflected 1997 through 2007.
Mr. Ruggiero advanced to slide 20 which showed regimes with
government take greater than Alaska (a large number of the
countries with overall nonproducer take greater than Alaska
getting investment from the major oil companies). He noted
that he had added Iraq to the bottom of the chart (it had
not been present in 2007). He stated that basically "Iraq's
round one and round two" was a government take of about 98
percent. He referenced an aspect of the Iraq contract and
detailed that if an oil company invested $1 billion, the
oil company received its $1 billion back prior to the split
of profits.
Representative Wilson asked about the acronym "PSC" [in the
charts on slides 18 through 20].
Mr. Ruggiero clarified that PSC stood for production
sharing contract. He elaborated that the charts included
three different types of oil patch contracts, which were
reflected in the legend [on the lower right side]. The
first was a royalty/tax system indicated with diagonal
lines and was equivalent to the Lower 48, Alaska, and some
other regimes. The black box reflected a PSC contract,
which was present in myriad countries. The third was a
service contract reflected by a checkerboard box, which was
similar to a PSC, but typically the company helping the
government was not allowed to take ownership of barrels. He
noted the company did not book reserves, but it may receive
value as though it had.
2:44:52 PM
Representative Grenn asked for a number or percentage of
countries looking for the same type of large fields Alaska
was. He asked if all the countries on the list [slides 18
through 20] were looking for the same type of fields.
Mr. Ruggiero responded that many countries would love to
discover a mega field, or an "elephant" as termed by the
oil industry. A large field always brought associated
development, jobs, and work. Everyone would love to have a
large field, but geology did not make it so.
Representative Grenn asked if Ireland was expecting to find
an elephant field. He asked for more detail.
Mr. Ruggiero replied that Ireland was at the top of the
list for the lowest government take; it had a very low
petroleum tax. Over several decades there had been attempts
to find oil in and around Irish onshore and offshore with
limited success. In order to keep the industry going, the
country charged very little government take. He used Iraq
as another example and explained that it knew it had
elephant fields prior to the conflict that shut its oil
fields down; therefore, it had designed its fiscal system
around the large fields.
Vice-Chair Gara wondered if there were regions that were
more similar to Alaska that could be used to compare
government take. He wondered if there were locations Alaska
was in higher competition with.
Mr. Ruggiero answered that when considering the top four or
five places that would be truly competitive with Alaska he
thought about the offshore eastern coast of Alaska and
compared it to places like Nova Scotia and Newfoundland
with high-cost, big reservoirs, harsh winter environment,
and other. Other locations included Norway, Australia (with
long lead-time projects and its offshore projects only),
subsalt basins in Brazil, and West Africa's deep-water
reserves. The examples were all large reservoirs with long
lead-time projects. He specified Angola as a primary
location in West Africa with all the same characteristics
of high-cost development with long lead-time and long-lived
reserves.
Vice-Chair Gara stated there were countries with high taxes
or low taxes that were nothing like Alaska where companies
went in knowing they may be nationalized (e.g. Venezuela).
He wondered if companies were willing to pay a bit more to
invest in safe locations.
Mr. Ruggiero replied that he did not want to oversimplify a
decision down to only one metric because decisions were
always based on a host of metrics. He detailed that when
coming up with a company's anticipated return on investment
for a project, the company upped their expectation prior to
choosing to invest in countries on the worst end of the
metrics, whereas they may have a lower threshold for
investing in countries on the better end of the scale.
2:50:42 PM
Representative Guttenberg asked for Mr. Ruggiero to discuss
a comparison between Alaska and Norway. He discussed that
Norway is a northern country with cold weather and a
challenging environment. Norway had significant [oil]
activity with a higher government take.
Mr. Ruggiero answered that the information would be a bit
dated, but he had personal experience from being posted in
the North Sea. The one thing Norway had brought to the
table was that it had a very involved government. He noted
he had not liked that at first, but had come to like it. He
elaborated that the government was involved with potential
designs, timing, and acted as a gatekeeper on what projects
got to come online because it wanted to minimize the
offshore pipe infrastructure. The country staged fields
based on when capacity would be available, instead of
building new lines; however, when there were four or five
discoveries Norway would commission a new line. He added
that the country had been the gatekeeper in terms of doing
things that were positive. Norway's government take was
roughly 78 percent, but it allowed rapid recovery of money
spent and had an investment credit/uplift companies were
able to get in the first four years of coming on and
spending money. There were numerous nuances that made it
attractive for companies to invest. Norwegian-owned
companies also had a substantial share of each project. The
reason numerous companies chose to do business in Norway
involved a combination of things involving how business was
done, how easy it was to work with the government, and how
well things got done.
Representative Guttenberg discussed that Norway had a
nationalized corporation functioning as a coordinator that
decided what projects to do and when. The corporation
parsed sections out to different companies with different
specialties. He believed the corporation coordinated the
activity for the benefit of the country and everyone took a
piece. He asked if he was accurate.
Mr. Ruggiero replied that it was an accurate representation
of what had taken place while he had been there.
2:54:13 PM
Mr. Ruggiero moved to slide 21 and discussed where Alaska
currently stood against the Lower 48. He stated that apart
from offshore, deep water in the Gulf of Mexico the
locations were not comparative. He addressed a comparison
beginning with only tax terms and explained that Alaska's
royalty was comparable to old royalties, but it was much
more favorable compared to new royalties and high
acquisition prices in the Lower 48. Even though newer
leases had higher royalties in the Lower 48, many of those
leases came with "drill or drop" clauses. He detailed that
some of the early leases signed in the Lower 48 contained
clauses that if a company drilled one well (many times it
was one well per square mile), the company could hold every
reservoir above and below ground in perpetuity as long as
the one well continued to produce. Royalty owners and their
representatives had learned quickly that development may
take place on adjoining sections where they may drill three
or four wells, but they could not force the person to drill
another well because all the acreage was held as long as
the one drill continued to produce.
Mr. Ruggiero explained that royalty owner associations had
gotten smarter and had developed clauses specifying if an
leasee had not drilled at least one well in a set amount of
time, they had to pay an annual rental on the lease. He
noted it became very expensive to hold onto property if no
development occurred. After a period of five to seven years
the leasee lost the land if no activity had occurred.
Leases also specified that the leasee had to keep up with
the tightest spacing - if neighboring leasees had drilled
four wells per square mile, it was necessary to drill four
wells instead of four. Although Alaska may say it had a
lower and superior royalty, the Lower 48 had a penal
financial obligation to ensure obligations were filled
under the new leases even though they were more expensive.
He noted that the charts from Daniel Johnston did not
include anything about "drill or drop" or about PSCs where
countries gave companies rights to in perpetuity whereas
others required activity on a property within three to five
years or the property was leased to another party. He
explained those were nuances that never showed up in
comparative tables.
Mr. Ruggiero addressed how Alaska compared to the Lower 48
based on the effective tax rate (slide 21). At current oil
prices Alaska's tax rate was low relatively speaking,
because they were all gross taxes, which were regressive -
the lower the price went, the worse the effective tax rate
came on the Lower 48 locations. He addressed exploration
and production credits - many had expired or had sunset
clauses. He discussed that Alaska had been unique when it
had the credits and it had been very valuable to companies
- he believed the credits had been responsible for some of
the activity levels in Alaska. Alaska also had a number of
unique aspects that operators did not run into in other
locations - operators did not have to worry about gas
versus oil or Cook Inlet versus Middle Earth or the North
Slope. There were some credits for horizontal wells or for
secondary recovery where there was some separation, but
primarily that type of separation did not exist in the
Lower 48. Alaska was unique in some positive ways, but it
was the only location he knew of that did monthly taxation.
Others collected monthly, but the taxes were annual.
2:59:19 PM
Vice-Chair Gara referred to a memo from Ken Alper (director
of the Tax Division, Department of Revenue) that translated
the effect of the actual profits tax rate in Alaska at
various prices. Mr. Alper specified that older non-GVR
[gross value reduction] fields had a 4 percent tax rate
until about $70 to $73 per barrel and GVR fields had no
minimum tax. The state had a zero percent production tax
until about $70 per barrel. He stated that some GVR fields
were post 2003 and some were new. He wondered if the state
was giving away too much with its GVR tax rate. He noted
that Point Thomson was one of the fields.
Mr. Ruggiero wanted to address the question the following
day when he presented a model. He would show a chart later
in the presentation and explained that the table Vice-Chair
Gara was referencing had been run with one set of costs. As
cost structures change - there was a wide range of costs
across fields - at different prices different people were
subject to the minimum or net tax. He believed the question
would be better answered with the model.
Representative Wilson remarked that it seemed the
discussion always pertained to only one piece of the
puzzle. She believed that when the committee talked about
the state's share, the discussion should include production
tax, royalties, severance tax, property tax, and other. She
thought the items should all be discussed at one time. She
asked if it was fair to try to fix one piece without
considering the whole structure.
Mr. Ruggiero agreed that the whole structure should be
considered. He detailed that when one-off issues were dealt
with separately it could cause issues somewhere else. In
making the decision to fix one piece, he assumed the
legislature was considering the structure as a whole.
Representative Wilson asked if the discussion the following
day would look at the entire scenario and would show how a
change to one component would shift things or bring in more
or less oil.
Mr. Ruggiero replied in the affirmative. The committee
would be able to modify sliding scales, minimum tax, GVR,
and other items to view the immediate impact [in the model
the following day]. He stated the model would allow one
change at a time or multiple changes to view the impacts.
Representative Wilson asked if the model would show how
much oil down the line the state could expect under various
scenarios. Mr. Ruggiero replied he could not predict the
information.
Representative Wilson stated that was her point. Her goal
was to see more oil down the line. She stated that if the
component was not part of the modeling, they had missed the
mark. She surmised they may get more money at the
beginning, but the change would mess things up in
perpetuity if it resulted in less oil down the line. She
thought it had to be a part of the puzzle.
3:04:07 PM
Mr. Ruggiero agreed it was important to find the way. He
thought it was a place the oil companies could help the
committee to understand existing oil that could be brought
on and the most significant hurdles facing companies and
preventing them from investing.
Representative Ortiz referred to slide 9 that highlighted
the state's overall goal. He asked about the relevance of
slide 21 pertaining to how Alaska compared to the Lower 48.
He asked if it was a critical question for the state to be
asking itself. Alternatively, he wondered if the more
significant question should be about how competitive Alaska
was with countries with similar regimes and reserves.
Mr. Ruggiero recommended looking at the regimes Alaska was
competing against. The arguments pertaining to the Lower 48
were included because they were easy, and it was easy to
draw a conclusion that may not be accurate. For example, he
did not believe Alaska should match the structure in North
Dakota just because it was producing more oil. He had
included the slide in response to the numerous questions
that had arisen about the Lower 48. He added that a graph
of North Dakota production over a 30-year period would look
pretty flat for 30 years. He noted that North Dakota had
not changed its fiscal system, the change had been in
technology. The state had gone from having average/sub-
average rock to great rock in terms of development at
present due to shale that was easily accessible.
Mr. Ruggiero continued to answer Representative Ortiz's
question. He shared that he had done a study a couple of
years earlier that looked at the top 75 non-major oil
companies in the U.S. Between 1990 and 2008 they had taken
on plus or minus $80 billion from private equity and hedge
funds. After the 2008 financial crash they had taken on
$110 billion between 2009 and 2014. They had gone from an
average debt to equity ratio of 40/60 to 90/10. He noted at
that time the price of oil had been above $100 per barrel.
He continued that the country had been in a prolonged
period of zero percent federal interest. Many industries
had been struggling and were not growing, but when the
price of oil collapsed with the financial crisis in 2008
and 2009 everyone had bet the price of oil would come back,
which it had done with a fury. Subsequently, all the money
poured in and continued to pour in even after the price
peaked at $120 to $130 per barrel. Much of the activity and
barrels were there because the money had been easy and
quick to receive.
Mr. Ruggiero continued that a couple of economists had done
as study that of all the money spent in North Dakota -
almost 10,000 wells had been drilled at an average cost of
$8 million per well ($80 billion invested) - after
royalties and severance taxes were subtracted, only about
$50 or so billion had been recovered. He added that most of
the wells were beyond their production peak. He stated that
they may have produced 1 million barrels of oil, but the
jury was still out as to how much money would be made in
North Dakota.
3:08:54 PM
Representative Guttenberg pointed to slide 21. He addressed
the last bullet on the right of the slide under the
relative risks category pertaining to competitive access
for all producers. He asked if the statement was true. He
asked for detail about unpredictable tariff levels.
Mr. Ruggiero answered by referencing his experience working
in the North Sea. He relayed that in the U.S. he had been
taught about all the things that could and could not be
done under SEC rules and what governments should and should
not do. He recalled being told by Norway to wait in line
for a development he brought forward. He explained that
Norway had seen all the problems with overbuilt facilities
and because its regime allowed the recovery of any money
spent (any unnecessary dollar spent was a dollar out of
Norway's treasury), the country controlled and ensured
access. He continued that if the parties involved could not
come to an agreement Norway deemed reasonable, the country
would intervene. He noted the country had direct, indirect,
and passive aggressive ways of intervening. He explained
that Alaska had one main pipeline and if the goal was a
long-term future on the North Slope, the state needed to
ensure that whatever needed to be in place and whatever
needed to be done was done to ensure any new player could
get access into the pipeline at fair and reasonable rates.
Representative Guttenberg shared that he had introduced a
facilities access bill in the past. He recalled meeting
with an independent CEO who had said that when he had been
young the facilities had been antiquated and if he had not
been given a good rate, it had been more economical to
build his own facility. He reasoned that not everyone had
the opportunity or economy of scale. He asked if there was
a way to show a history of access fees and who had paid for
what and how competitive it was for various partners or
independents. He asked how restrictive it had been for
people.
Mr. Ruggiero replied that he did not have access to that
data. He added it would be a good question to ask the TAPS
owners.
3:12:24 PM
Mr. Ruggiero moved to slide 22 and addressed more regimes
using self-correcting mechanisms. He referred to his
recommendation to use a net tax system with brackets to
mimic what the state currently had. He spoke about
historical actions resulting in different outcomes, many of
the outcomes were due to firm triggers at prices. He
relayed that more and more regimes were using self-
correcting mechanisms. In order to get additional
production and new developments, a self-correcting system
could predict what was going to happen. He explained that a
self-correcting system would know exactly how low
profitability in the current year, a high write off, or
great profits the following year would treat them. The
economics could be set up and run. He acknowledged there
would still be the risk that any legislature could change
legislation at any time, but it would be much more
predictable. He provided a hypothetical scenario where a
system was not predictable - an entity's costs would be
high, the trigger would be at $90 and costs would be $75,
and the entity wondered if it could move the trigger up so
the costs were not as onerous.
Mr. Ruggiero continued to address the benefit of a self-
correcting mechanism. He detailed that in practice, taxes
were set ahead of time (i.e. guessing about the future). He
stated that oil patches changed often and regularly and
there was not the ability to set a tax regime with 20:20
hindsight. A number of mechanisms had been developed and
put in practice to allow fiscal systems to adapt to
changing markets. He listed numerous options including
profit per barrel, overall rate of return, and an R-Factor
(the amount of money received versus the investment
amount). All the options could be set up with one or more
brackets and provided different ways to establish a long-
term durable system.
Mr. Ruggiero addressed slide 23 titled "Why use Self-
Correcting Mechanisms." He explained that every government
and legislature had thought it was doing the best it could
at the time they agreed to something in a bill. He agreed
the action lasted for a while, but because of the biases of
every system, the future would bring some unintended
results (either because prices were higher or lower than
anticipated or there were interdependencies where a fix to
one area inadvertently impacted other areas in a
structure).
3:16:08 PM
Mr. Ruggiero addressed the flaw of averages and avoiding
unintended consequences on slide 24. He shared that in his
past experience with ACES and later, the average numbers
had tended to be used. He did not know of a field that had
the average transportation or cost rate - they all had
either lower or higher rates than the average. When a
system was designed around averages did not address the
outliers. He pointed to a cartoon on slide 24 depicting a
stream that was three feet deep on average, but that did
not address the 20-foot hole partway across the stream. He
stated it was acceptable to use the average for general
descriptions, but it was important to consider the range.
He referred to a slide provided the previous day by DOR
related to tariffs. The slide had included tariffs ranging
from $9 to almost $30 per barrel. He underscored that when
building all the models and systems, the use of a $10
average would be wrong. He spoke to the importance of
testing systems as they were built.
Mr. Ruggiero moved to slide 25 and addressed effective tax
rate at costs of $40, $55, and $65 per barrel. The graph
showed the existing system under SB 21. He explained that
the three sets of lines resembling the shape of a hockey
stick used a total tariff and operating cost of $40, $55,
and $65 per barrel. The lowest point came down at roughly
$73 per barrel - it included a 4 percent minimum tax. When
average numbers were used, at $73 per barrel, instead of
paying the gross minimum, a net basis was used. At a $55
per barrel cost, the number moved up to somewhere around
$76 to $77. At a $65 per barrel cost, the number increased
to over $85 per barrel where the minimum gross tax would be
paid at every price below that number ($65). He pointed out
that the top end did not move because a stake had been set
at a specific price. As cost structures went up over time,
the tax increased. He stressed that the cost structure used
in a model would give a different answer about where
something should or should not be done. He advised that
during his modeling presentation the following day the
committee should consider low and high ends to go with the
average to see all three.
Vice-Chair Gara asked for verification the slide showed the
non-GVR fields, not the GVR fields that did not pay the
minimum tax.
Mr. Ruggiero replied in the affirmative. He detailed the
fields on the slide all paid the minimum tax (it did not go
to zero). The graph had been run with a 4 and 5 percent
minimum gross tax.
3:20:09 PM
Representative Wilson asked for a brief description of GVR
versus non-GVR fields.
Mr. Ruggiero replied that within the current legislation,
for fields that met certain criteria to be deemed a new
field, companies could take a 20 percent deduction from the
gross value at the wellhead. He noted another 10 percent
could be added as well. It was a deduction for new fields
along with a $5 per barrel credit. The graph on slide 25
showed a minimum tax being payable at very low prices
because the per barrel credits could not pierce the floor,
but the GVR fields could (meaning the tax could go to
zero).
Representative Wilson asked if the slide related to the big
three oil companies or other.
Mr. Ruggiero answered that slide 25 did not reflect
specific companies. He elaborated the slide provided a
representation of what would happen when the total cost
structure of non-GVR eligible fields changed. The chart
indicated the point when fields switched from paying the
gross minimum to paying the net tax. He referred to an
earlier question of what happened at 7, 8, or 9 percent
[taxes] and relayed he would model the information the
following day to see the impact. As long as there were
anchor points (the sliding barrel credit had anchor points
at $150, $140, and $130) on the right side, but costs moved
the left side of the graph. He would provide additional
detail the following day.
3:22:27 PM
Mr. Ruggiero addressed slide 27 pertaining to the value of
extending the life of legacy fields. He had heard numerous
people say that Alaska had numerous giveaways to new
fields. He used the following assumptions shown on slide
27:
· Assumptions
o 250,000 bpd physical shut in rate
o 50,000 economic shut-in rate
o New oil sufficient to keep pipeline running
into the future
o 6% decline on legacy from 250k to 50K
o Prices $50 to $100 ANSWC
o Net tax rates from 5% to 35%
Representative Ortiz asked what the physical shut-in rate
was.
Mr. Ruggiero answered that the physical shut-in rate was
the rate where there would be so little flow in the
pipeline that it could not keep running. There was a
minimum rate required to keep the pipeline running. The
economic limit shut-in rate would be for the legacy fields
- once production got down, given the number of wells and
facilities, the costs would probably start to outrun the
revenue. There was a large fixed cost for running the
fields. He noted that the assumptions on slide 27 were
guesses. The third assumption listed on the slide was the
development of sufficient new oil to keep the pipeline
running. He had used a 6 percent decline rate on the legacy
fields "from 250k to 50k." He had looked at prices between
$50 and $100 and at net tax rates from 5 percent to 35
percent.
Mr. Ruggiero estimated that extending the life of legacy
fields could result in additional revenue to Alaska ranging
from $5 billion to $50 billion in petroleum tax, royalty,
and property tax. He stressed there was value in keeping
the legacy fields operating. He remarked that if companies
knew the pipeline would have a long life, there may be
additional work they would be encouraged to do because they
had the other fields keeping the flow going at a high
enough rate. He noted that Caelus's Smith Bay project had
extremely light oil and light oil relative to all the
heavier oil would help tremendously in the operation of the
pipeline; it would enable much heavier oil to be produced
and blended out.
3:25:42 PM
Mr. Ruggiero addressed the time value of money on slide 29.
He had modeled a hypothetical field that bore no
resemblance to any existing field. The model included an
investment of $100 in year-one, $400 in years two through
ten, $100 in cost recovery to the producer, and $300 of
profit split between the producer and government. He
underscored that it was the same amount of money in the
same years. The only alteration to the model would be who
received the money when.
Mr. Ruggiero turned to slide 30 and addressed differences
in cost recovery based on the hypothetical scenario on
slide 29. The graphs on the left showed immediate
deductibility recovery with (with no uplift). The top graph
on both sides used the total available money within a year
and showed the percentage split between the producer (blue)
and the non-producer (green). The plot on the bottom left
and right showed the actual dollars during the period. The
example on the left showed accelerated cost recovery - the
small amount of non-producer recovery in years three and
four mirrored receiving a royalty, with the remainder going
to the producer. The lower left chart showed an IRR of 20
percent. If the recovery was spread out over five years
(the amount of costs to be recovered was limited by
spreading it across the five-year period), the producer's
economics on the project worsened and dropped to a 14
percent IRR. The net present value (NPV) was almost cut in
half.
3:28:51 PM
Mr. Ruggiero moved to slide 31 and addressed cash credits
versus 50 percent NOL. He explained the chart would show
why many companies were interested in cashable credits
ahead of time versus waiting for production and taking
deductions later. The chart on the lower left showed the
state as an investor in year-one of 35 percent cashable
credits. The producer IRR went to 27 percent. He reminded
the committee the scenario had provided a 20 percent IRR
with accelerated recovery and a 14 percent IRR with delayed
recovery. He pointed to the charts on the right where the
company was only allowed to recover 50 percent of its costs
- the IRR decreased to 6 percent and the NPV was negative;
it was a "definite no-go project." Taking the same
hypothetical field and applying various ways of handling
the recovery or deductibility of cost, provided vastly
different results.
Mr. Ruggiero referred to an earlier question about why a
company may chose to invest in a 78 to 90 percent
government take country, while questioning investment in
Alaska at a 60 percent government take. The answer was due
to things like the items presented on slides 30 and 31 - it
was the things that were hidden that were not always seen
when graphical comparisons of regimes were conducted. He
noted that each of the graphs could represent countries A,
B, C, and D as well. He had run an analysis of an existing
field in seven different countries, which had resulted in
an IRR ranging from 4 to 38 percent. The counties used all
had very different tax regimes. He stressed the importance
of considering the system as a whole, and looking at real
possible fields. Even though the same royalty and tax rate
was applied in his hypothetical example, there were very
different results (slides 30 and 31). He spoke to the goal
of filling the pipeline and noted that the state did not
have 100 different operators or 100 potential fields to be
developed. The number of operators could be counted on one
or two hands and the number of potential fields that could
be developed to keep the pipeline running was minimal.
Those facts would need to be considered when making changes
to the tax system.
3:32:22 PM
Mr. Ruggiero spoke to slide 32 titled "Impact of Interest
Rate on Time Value of Money." He had included the slide
based on discussions about uplift and interest rates and
what it was worth or not worth. The y-axis (vertical)
showed a number of years and the x-axis (horizontal) showed
an interest rate starting at 4 percent increasing in 2
percent increments up to 20 percent. The boxes highlighted
in yellow indicated the number of years it would take to
double your money. In a conversation about providing uplift
to an NOL or other, the chart would be a quick interest
rate guide (if money had never been deducted). He used the
2 percent interest (highlighted in yellow) as an example -
if an 8 percent uplift was offered, the money would double
in size in nine years. He detailed if the NOL was $100 and
it was not deducted during that nine-year period, it would
be worth $200 in the ninth year.
3:34:05 PM
Mr. Ruggiero concluded his presentation on slide 34 related
to question topics that had come up in testimony. He
mentioned questions pertaining to what other countries and
other regimes did, how different mechanisms worked, and
what may be perceived as good or bad in various countries.
Representative Ortiz relayed that the previous day he had
asked about the concept of hardening the [tax] floor. He
asked if hard floors were common in other regimes.
Mr. Ruggiero answered that any regime that has royalty, by
definition, has a hard floor. The gross tax in Alaska was
no different than royalty; it could have just been added to
the royalty and it would work the same way. There were
other countries with somewhat of a net-based system that
would put in a minimum. Countries or regimes that depended
on oil revenue for 30 or more percent of their treasury
intake, had mechanisms including hard floors within their
fiscal regime, to get revenue every year. Others only
depended on oil for 2 to 3 percent of their treasury -
those companies typically had an absence of floor or
minimum because they were not reliant on oil to keep
government running.
Representative Ortiz surmised that a floor in terms of a
production or severance tax was not very common. Mr.
Ruggiero responded that with the clarification that royalty
acted as a floor, it was very common because royalty was
very common.
Representative Guttenberg referred to information sharing
in other regimes and what information was shared in Alaska
versus what was not. He referenced the ability to know what
was going on to make a decision. He asked for detail.
Mr. Ruggiero addressed his experience working with the
Netherlands, UK, and Norway in the North Sea. He relayed
that before he ever recommended moving forward on a project
to executive management he had two to five meetings with
different governmental agencies to go over the project
(i.e. to address the reservoir, how much money would be
spent, how many drills would be needed, what pipeline would
be used, and other). He continued that during the first
meeting they may discuss numbers plus or minus 50 percent,
but by the end, the agencies would know where and how he
planned to drill and what he expected to earn. He had
involved parties ranging from engineers to treasury
officials. By the time he received internal approval to go
forward, filing the petition for the right to develop would
be a foregone conclusion.
Mr. Ruggiero explained the process had been beneficial
because government agencies may have suggested moving a
well a bit to the north or talking to a company because
capacity may have been opening in its facility. The process
had also been the governments' way of ensuring an optimum
amount of facilities were built. In regimes that allowed
companies to recover or deduct costs, every dollar that was
deducted or recovered was a dollar that did not go into the
treasury (it was not exactly dollar for dollar, but close).
He stated that those countries were much more involved and
much more information was shared. He had worked on
development projects in other countries where the agencies
basically saw everything the company had except for the
sales contracts. The North Sea countries were beginning to
take it to a further extreme. He could provide some links
at a later time. He detailed that it was possible to go
into Norway, look into a field and find the ownership
history, the production, the annual capital expenditures,
the five-year forward forecast, what rig had drilled a
well, and other information. The information was all
accessible online.
3:40:31 PM
Representative Guttenberg discussed that Alaska had some
significant credits. He explained that the numbers were
aggregated, and it was not possible to see the impact of
the credits and where they had been successful or
unsuccessful. He asked if there were similar regimes
(outside of taxes) where it was possible to analyze what
was effective and what was working. The goal was for
credits to result in increased production. He asked if
[visibility into the data] was a reasonable thing to ask.
Mr. Ruggiero answered there was a significant amount of
available data that would not be a violation of SEC rules
if disclosed. He noted there was a fine line between when
that line was crossed; however, there was substantial
information that could be made available. He noted that the
state did not necessarily need to have the taxpayer
information. He explained that much of the data that went
into a tax return was also very basic data on production,
amounts of oil in pipelines, wells drilled, and other. He
believed there were numerous things the state could ask for
and see without putting the state or oil companies at risk
of violating any laws. He added that companies provided the
information internationally.
3:42:37 PM
Representative Wilson asked how many regimes had changed
their tax structure as often as Alaska.
Mr. Ruggiero replied it depended on the timeframe. There
was a survey that went out to company executives that rated
the attractiveness of fiscal regimes. One of the places
that had always been near the top of the list was the
United Kingdom. He relayed that from 1981 going forward,
the UK had changed its fiscal regime more than any location
in the world, yet it was considered one of the top three
stable places to conduct business. The country was quick to
remove terms and lower rates when prices went way down, but
it was equally quick to raise rates and government take
when prices increased.
Representative Wilson asked if the state was doing damage
to its reputation. She believed the state appeared to be
constantly looking at its fair share as being more.
Mr. Ruggiero replied that it all came down to timing and
direction. He elaborated that if it was in the right
direction at the right time it would be overlooked and
people would move on; however, it became more problematic
if change was perceived to be in the wrong direction or was
late to the game.
Representative Wilson referred to Mr. Ruggiero's testimony
to the importance of ensuring the barrels flowing through
the pipeline in Alaska did not fall much farther. She
observed that it was not possible to change how cold it was
or difficult it was to operate on the North Slope. She
asked if it was the right time and move to change the
state's tax structure in HB 111.
Mr. Ruggiero replied it depended on how the system was
changed.
Representative Wilson asked looked at HB 111 as currently
written. She asked if the bill would be positive or
negative for the state if it passed in its current form.
Mr. Ruggiero believed there were aspects in the bill that
would make a change in the wrong direction.
3:45:39 PM
Representative Pruitt stated that he had a conversation
with some Scottish investors several years earlier. He
recalled that the individuals had complained that
Westminster had increased the rates too high. He noted that
the individuals had thought the change had occurred too
quickly. Subsequently, there had been a change back that
recognized prices were low. He surmised the issue was not
necessarily that Alaska was changing the tax structure, but
it was what the state did when it made the change. He
looked at the fiscal note and observed that the bill asked
for a tax increase. He did not believe it was the direction
the UK would go under the current price environment. He
asked for comment on his statement.
Mr. Ruggiero was not aware of what the UK was currently
doing. He believed Representative Pruitt's point was the
bill would result in a revenue increase to the state. He
recommended looking at the state's goals and determining a
balance. He returned to slide 9 regarding the state's
priorities. He explained the state had opposing drivers -
the long-term indicated the state needed to go in one
direction, while the short-term indicated the need to go in
a different direction. The state needed to decide how far
to tilt to the right before causing significant damage to
the left. It was necessary to determine the goal prior to
making decisions on taxation. Too many times changes were
made to fix a problem that had no relation to the overall
goals. If the goals were used as a guide, it became a
matter of the balance and how far it was tilted one way or
the other.
Representative Pruitt appreciated the recommendation to
begin with the state's goals to determine how to make the
policy. He added that the current bill was not the only
bill the legislature should use that recommendation for.
3:48:45 PM
Representative Tilton spoke to Mr. Ruggiero's testimony
about changing regimes in the right way at the right time.
She noted that HB 111 would increase government take in
Alaska. She referred to slide 21 from an Alaska Oil and Gas
Association (AOGA) presentation from the previous day. She
detailed the slide had specified that regimes worldwide
were looking at more fiscal incentives rather than
increasing government take. She asked Mr. Ruggiero if he
believed HB 111 was being considered at the right time.
Mr. Ruggiero answered that looking at the AOGA chart and
one he had used as well, government take tended to increase
when oil prices rose and decrease when prices fell.
However, about one-third of the locations on the chart were
in the opposite direction. He returned to slide 9 and
relayed that although those governments were going in the
opposite direction, there had been a reason that had been
specific to that location. The locations had been trying to
balance out their goals. He agreed that when a tax regime
went in the wrong direction industry would let a government
know. He added that it definitely did not help when
companies had to pay more taxes. He believed it was
necessary for the legislature look at the state's overall
situation and to look at goals and priorities as a state to
find the right balance.
Representative Pruitt stated that during discussion on SB
21 they had heard comments that ACES had not been modeled
at higher numbers. Similarly, the legislature was currently
hearing that SB 21 had not been modeled at lower numbers.
He asked if it was possible create a system that addressed
both ends. He noted Mr. Ruggiero had mentioned that other
regimes adjusted as prices increased. He asked if it was
possible to implement something that would not require
consistent alteration.
Mr. Ruggiero corrected that during ACES he had been
requested by the House Finance Committee to run prices up
to $400 per barrel. He had presented prices from zero to
$400. He shared that thousands of scenarios had been made
based on requests from the committee at the time. He
addressed how to make something self-correcting. He
recommended basing trigger points (when changing an
incentive, credit, or tax rate) on something calculated at
that time based off profitability, not price or gross. The
profitability could be unit profitability - ACES had been
based off unit profitability. He clarified that ACES did
not do anything at prices of $60 per barrel. He could
predict what ACES had done at $60 of profit per barrel, but
not at a price of $60 per barrel. He had seen many
presentations misrepresent ACES. He spoke to getting into
understanding things based on net and profitability versus
things based on gross or fixed points. He referred to one
of his recommendations of a bracketed net system, which was
based off unit profitability. Currently, there were people
at the very low end of unit profitability (e.g. gas in Cook
Inlet) and people at the higher end of unit profitability
(e.g. large legacy fields). A system that taxed or
approached companies based on their profitability was much
more responsive and predictable going forward.
Representative Pruitt noted that he had not been present
during ACES and had only heard the conversation about SB
21. Mr. Ruggiero replied that he had also been blamed for
the 0.4 percent progressivity, but it had been the other
body.
Co-Chair Seaton referred to the 10 percent GVR for any
field above 12.5 percent royalty. He had been trying to
figure out why it would be reasonable to use the production
tax system to reverse royalties when people bid on oil
fields based on timing and bid terms higher than 12.5
percent royalty. He surmised the provision took away more
royalty than would be reasonable. He asked Mr. Ruggiero had
comment or would address the issue the following day.
3:56:13 PM
Mr. Ruggiero answered it was something that could be shown.
He added that he had been dumbfounded by the concept that
if a company had just accepted 2 more points in its
royalty, it would get a 10 percent royalty reduction. He
did not understand why the provision had come into being.
He explained that the 10 percent extra on the GVR was
applied to the same dollars as the royalty. He expounded
that if a company agreed to 2 more points upfront it would
get 10 off the back end, meaning it would be a net 8 points
better off. If that type of relief was necessary for a new
field, the state already had royalty relief in place in
statute and regulation; when needed companies could apply
for the relief and could show why and for how long it would
be needed.
Co-Chair Seaton stated he was concerned about how the
provision impacted the entire [tax] regime. He believed
that going to a 30 percent GVR would significantly distort
everything that had been attempted.
HB 111 was HEARD and HELD in committee for further
consideration.
Co-Chair Foster provided the schedule for the following
day.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HB 111 032317 HFIN HB111 Castle Gap (003).pdf |
HFIN 3/23/2017 1:30:00 PM |
HB 111 |
| HB 111 Alaska Sedimentary Basins.pdf |
HFIN 3/23/2017 1:30:00 PM |
HB 111 |
| HB 111 3.22.17 Gara ConocoPhillips Earnings.PDF |
HFIN 3/23/2017 1:30:00 PM |
HB 111 |