Legislature(2007 - 2008)SENATE FINANCE 532
02/01/2008 09:00 AM Senate FINANCE
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| Start | |
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| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| *+ | SB 242 | TELECONFERENCED | |
| + | TELECONFERENCED |
SENATE FINANCE COMMITTEE
February 1, 2008
9:14 a.m.
CALL TO ORDER
Co-Chair Stedman called the Senate Finance Committee meeting
to order at 9:14:15 AM.
MEMBERS PRESENT
Senator Bert Stedman, Co-Chair
Senator Kim Elton
Senator Donny Olson
Senator Joe Thomas
Senator Fred Dyson
MEMBERS ABSENT
Senator Lyman Hoffman, Co-Chair
Senator Charlie Huggins, Vice-Chair
ALSO PRESENT
Pat Galvin, Commissioner, Department of Revenue; Dan
Dickinson, Consultant, Tax Division, Department of Revenue;
Steve Porter, Legislative Consultant, Legislative Budget and
Audit Committee, Legislative Affairs Agency
PRESENT VIA TELECONFERENCE
None
#SUMMARY
SB 242 "An Act relating to lease expenditures that may be
deducted for purposes of the production tax on oil
and gas; relating to the retroactivity provisions
of changes to the production tax on oil and gas
enacted in ch. 1, SSSLA 2007; and providing for an
effective date."
SB 242 was HEARD and HELD in Committee for further
consideration.
9:14:58 AM
SENATE BILL NO. 242
"An Act relating to lease expenditures that may be
deducted for purposes of the production tax on oil and
gas; relating to the retroactivity provisions of
changes to the production tax on oil and gas enacted in
ch. 1, SSSLA 2007; and providing for an effective
date."
STEVE PORTER, LEGISLATIVE CONSULTANT, LEGISLATIVE BUDGET AND
AUDIT COMMITTEE, LEGISLATIVE AFFAIRS AGENCY provided a brief
sectional analysis of the bill. He pointed out that the bill
covers two issues; it removes the standard deduction
contained in Section 1 and Section 5, subsections (k) and
(l) from the Statute. This changes the law as passed from a
standard deduction for three years, to a more normal
deduction for operation expenses. He asserted that the
legislation also moves the retroactivity date from July 1,
2007 to December 20, 2007, which is the effective date of
the bill. He emphasized that, while the changes seem simple,
the effective date change requires revisions to several
sections. Co-Chair Stedman remarked that the standard
deduction applies to the older and larger reservoirs,
Prudhoe and Kuparuk, where most of the revenue originates.
9:17:10 AM
PAT GALVIN, COMMISSIONER, DEPARTMENT OF REVENUE elaborated
on the issue revolving around the retroactivity of the
entire statute, which would affect all fields and all tax
payers equally. It reflects a provision discussed throughout
the session and submitted by the Senate Finance Committee
when the bill was ultimately passed. Co-Chair Stedman
indicated that the Senate Finance Committee amended the
retroactivity provision of the bill from twelve months to
six months. Mr. Galvin commented that the standard
deductions issue only affects the two large fields, Prudhoe
Bay and Kuparuk. The standard deduction provision was
initiated on the House floor, but did not contain a sunset
when it moved to the Senate. He remarked that the Senate
added the standard deduction provision with the sunset. The
standard deduction affects the operating expenditure
deductions for Prudhoe Bay and Kuparuk for the tax years
2007, 2008, and 2009. Mr. Galvin explained it limits and
freezes the amount of applicable deductions. The standard
deduction is based upon the claimed expenditures in 2006. He
noted the Administration acknowledged these provisions were
not part of the original proposed bill, and although they
did not oppose the changes they were not pushing for or
advocating any of them. The retroactivity provisions were
not included in the original bill, only later added by an
interim committee. He voiced that the Administration
believed this provision unnecessary but recognized the
inevitability of compromise to pass the bill. Mr. Galvin
confirmed the Governor's support for the final bill in the
belief that it is not appropriate to extract or amend the
two pieces that are the primary components for many who
supported the bill.
9:20:58 AM
Co-Chair Stedman requested further explanation on what the
standard deductions actually target between operating
expenses versus capital expenditures. Mr. Galvin explained
that the taxable amount is calculated by taking the gross
revenue at the field level then subtracting the operating
expenditures and the capital expenditures. The capital
expenditures provide a further credit to reduce the tax
bill. Mr. Galvin continued that the standard deduction only
applies to the operating expenditures, the normal day-to-day
operation costs but does not limit the deductibility or the
credits available to capital expenditures, such as new
investments; therefore it would not cause any disincentive
to new investment in further exploration or new development.
9:22:37 AM
Senator Elton requested more information about the fiscal
note and the suggestion that adopting the present bill would
be an $800 million loss to the treasury. He also questioned
how the $800 million figure had been reached. Mr. Galvin
indicated that the figure was based on the retroactivity
aspect for the amount of tax receipts received during the
period from July 1, 2007 to December 20, 2007. He noted that
this indicates the different value of the taxes that existed
before ACES was passed and what ACES provided. He reported
that the figure is not based on any expectations on the
standard deduction because, at present, there is no
estimate.
9:24:17 AM
Senator Dyson questioned if the Administration, not
proposing the idea of the standard deduction or
retroactivity, considered this to be a good bill. Mr. Galvin
stated the Administration recognized that the bill addressed
some of the concerns raised regarding the ability to get up
to speed and manage the auditing. He acknowledged that the
Administration accepted that having a frozen number for a
limited period of time provided comfort to many. He stressed
that the Administration felt very strongly that the sunset
provision had to be included because it would provide a
different impact on the potential behavior on the type of
investment that was desired and a limit on operating
expenditures beyond 2010. He noted that the Administration
was more concerned about the retroactivity provision, but it
was recognized that compromise was necessary to get support
for the bill. Mr. Galvin indicated that trying to return
months later and extract these provisions would be a
difficult undertaking. Senator Dyson questioned why this
would be a problem. Mr. Galvin observed that this would not
be in keeping with the "good faith" effort that was put in
the bill to reach a compromise.
9:27:08M
Senator Dyson indicated he would like further discussion on
the impact the provisions would have on the investment in
the challenged or heavier oil. Mr. Galvin observed that the
sunset provision was needed, so as not to see any
disincentive to the investment in the heavier oils or higher
costs oils. The Administration was looking at the "ramp up"
time associated with making that type of investment. He
remarked that the pursuit of heavy oil will require a lot of
up front capital expenditures and higher operating
expenditures leading out. The sunset provision on the
standard deduction would allow for the "ramp-up", but would
not hinder the deduction of those expenditures once they hit
the operating side. Mr. Galvin noted that the potential risk
on the part of the standard deduction to dampen this kind of
investment was mitigated by the sunset provision to a large
extent.
9:29:20 AM
Co-Chair Stedman inquired if the Administration helped in
crafting any of the language and, if so, when. Mr. Galvin
noted the standard deduction provision came out of the
House. He revealed the Administration's ongoing discussions
with proponents of a gross based tax, those uncomfortable
with the implications of a net based tax, which it was felt
would result in risk to the state. He remarked that the
efforts to find a mechanism to reduce what was seen as
"risks" formed the idea of a standard deduction and a
standard expenditure provision. He noted the Administration
commented on what they perceived as structural flaws in the
proposal. Mr. Galvin reported that the standard deduction
was initially introduced in the House Finance Committee; the
only time it had a public hearing. He remarked that the
Administration did not object to the standard deduction
provision, at that time, in recognition that it addressed
concerns, and was limited to a single number as opposed to a
per barrel number, and included a sunset date. This had been
a concern for the implications it would have in terms of
motivations on production and the fact that it would sunset.
Mr. Galvin noted that the provision failed in the House
Finance Committee. He signified the provision did not
include a sunset provision when it was passed in the House
but the sunset was added back on the Senate Floor.
9:32:35 AM
Co-Chair Stedman observed that the Administration was active
in crafting the language and reviewing the provisions. Mr.
Galvin responded that the Administration was active in
responding to the people drafting these provisions in
attempting to minimize the potential negative impacts. He
expressed the Administration was able to reach a point of
agreement.
9:33:05AM
Senator Thomas appreciated Mr. Galvin's review of the sunset
provision. He inquired if a figure existed for the 2006
deductions and questioned if there was a ten per cent
flexibly either way. Mr. Galvin explained that the standard
deduction is calculated by taking the reported expenditures
for 2006 for the two fields, but since there was only a nine
month period of time it must be expanded (multiply by 133
percent) to get the number for the entire calendar year. He
explained that the number then goes up three per cent for
the three years it will be used. He remarked there has been
an ongoing difficulty in providing numbers on a "field
specific" basis. The public disclosure information
provisions pertaining to costs were not retroactive, which
made it impossible to show the 2006 amount. Co-Chair Stedman
indicated that part of next presentation would address where
to sort through these limitations.
9:35:29 AM
Senator Dyson believed that this has been a challenging
process. He noted that the Chairman of the Committee wanted
a lower base tax rate and championed the progressivity in
which Senator Dyson agreed. Senator Dyson believed that the
higher tax rate on the industry, and any negative effects,
only happened when times were good and everyone was making
money. The end result was a significantly higher
progressivity and higher base tax rate than the
Administration recommended. Senator Dyson acknowledged the
discussion concerning possible negative impacts for the
industry's investment and conceded that part of the trade
off was to eliminate the floor on the taxes. Senator Dyson
believed it would not make any difference in the near
future. He questioned if the Department of Revenue and the
Administration were comfortable with the combination of a
higher base tax rate and a significantly higher
progressivity than they originally recommended. Mr. Galvin
acknowledged that the Administration and Department of
Revenue supported the trade-off. Senator Dyson clarified his
question to ask what the higher rate of progressivity did to
attract and encourage more production. Mr. Galvin replied
that the slope of the progressivity curve provides an
incentive for those with a large amount of production in a
field with high margins. He remarked that to invest in a
field that will have a lower margin, with state
participation in capital credits, when the production comes
on line, will dilute the margin for their entire production
portfolio. He cited that will reduce the progressivity for
the production that they currently experiencing during high
progressivity. He stressed that a double incentive is
created because it lowers the tax rate on their exiting
production as well. Mr. Galvin pointed out that the
investment decision also recognizes potential risks, such
as; when prices come down will money be made at a stress
price. He noted when the rate is driven by the progressivity
it allows for that investment to be looked at from the lower
prices and have positive economics. At the higher prices,
the State of Alaska experiences more, but the economics are
still positive due to the high prices.
9:40:37 AM
DAN DICKINSON, CONSULTANT, TAX DIVISION, DEPARTMENT OF
REVENUE presented an overview of the two major issues in the
bill, which are the change in the effective date for a
number of the financial terms from July to December and the
use of the three percent markup when calculating operating
costs (SB 242 - Two Production Tax Changes, p. 2, copy on
file). He agreed with Commissioner Galvin that questions on
the "long term" effects are difficult to answer during the
three year program that has been laid out. He explained that
the first issue deals with the change in the effective date
moving the major revenue sections, retroactively, from July
1, 2007 to the original effective date of the bill, December
20, 2007. He noted a number of clauses going back to April
1, 2007 and items requiring advance approval from the
Department of Natural Resources were not changed. Mr. Galvin
acknowledged that the Department of Revenue will be required
to write regulations to define how producers will fill out
their tax forms when there are two tax regimes. This bill
will not change that but instead of being a fifty/fifty mix,
there will be three hundred fifty three days under one
regime and eleven days under the other (SB 242 - Change
Effective Date, p. 3, copy on file).
9:44:28 AM
Mr. Dickinson commented on the effects resulting from the
changes. He asserted that $1.6 million more would be raised
with the passage of the bill and an additional $160 million
would be collected by the change at the rate of 22.5 percent
to 25 percent. He commented the major effect, involving more
than half the dollars, is the result of the progressivity.
Mr. Dickinson noted the change in credits would be
determined on how the Department of Revenue writes the
regulations (SB 242 Change Effective Date, p. 4, copy on
file). Co-Chair Stedman requested a reminder on the volume
and price used in this analysis. Mr. Dickinson reported that
the fiscal note was based on $71.65 per barrel and the
volume of 730,000 barrels per day. He reminded the Committee
that oil production does not follow a steady curve
throughout the year. He pointed out the large drop
(indicated on the slide) in ACES from 2008 to 2009 resulted
from the Governor's proposal of not containing the
retroactivity that was later added by the Legislature (SB
242 Change Effective Date, p. 5, copy on file). Co-Chair
Stedman remarked that the 2009 number used is $64.55 per
barrel, but some analyses have used a $90 per barrel figure.
He wondered if oil prices maintained a higher level, such as
$70 to $80 per barrel, what the relationship would be
between the Governor's bill and the final bill.
9:49:03 AM
Mr. Dickinson remarked that in breaking down prices,
remaining constant at $90 per barrel for FY 08 and FY 09,
the major difference would be the change in the effective
date. Co-Chair Stedman questioned if there would be a
substantial increase in FY 09 numbers due to progressivity,
the change in the base rate from twenty two percent to
twenty five percent, and the credits moved fifty percent
forward. He wondered if it would be possible to calculate
the rate from the projected $64.55 a barrel to $70, $80, and
$90 a barrel. Mr. Dickinson speculated that at $94.55, a $30
increment, then under the progressivity of .04 percent for
every dollar, another 7.5 percent is added to the tax rate.
This figure would be closer to a forty five percent tax
rate. Co-Chair Stedman requested further calculations for FY
09 based on the figures of $70, $80, and $90 per barrel. Mr.
Dickinson replied that for FY 09, based on $80 per barrel,
the increase is approximately $500 million. He will further
research the statistics for the other requested per barrel
figures.
9:52:28 AM
Senator Thomas inquired if the $1.6 billion was the old or
updated estimate. Mr. Dickinson replied that the figure was
from the fiscal note. He continued commenting on the second
issue dealing with the Kuparuk and Prudhoe Bay units that
represent about seventy five percent of the volume being
produced. The new rules used the FY 06 figures as a base
then applied a three percent operating expense "mark up" for
the calendar years of 2007, 2008, and 2009. Additional costs
will be disallowed if the oil company's operating expenses
are higher than the three per cent figures. He noted that
lower operating costs would benefit from a higher deduction.
The net tax began on April 1, 2006; therefore the base is
determined by nine months of costs for the calendar year
2006. Mr. Dickinson observed in 2007, the base will be one
hundred thirty seven percent of the 2006 amount. For the
calendar year of 2008 and 2009, the allowance will be one
hundred three percent of the prior year (SB 242 Kuparuk &
Prudhoe Units Opex, p. 6, copy on file).
9:55:10 AM
Mr. Dickinson elaborated that "costs" is determined by
dividing the fixed costs by the variable costs (Opex fixed
or variable cost?, p. 7, copy on file). This distinction is
important in determining how the three percent increase
functions. He illustrated if the operating costs are fixed,
then there is a one hundred three percent increase. If the
operating costs are variable, then it would be a one hundred
ten percent increase. He continued that if the 2006 costs
were $2 billion, then the three percent increase would raise
the allowance to $60 million in 2007, the 2008 figures would
increase to $121.8 million and 2009 to $185.5 million.
9:57:31 AM
Mr. Dickinson observed that older fields are declining at
roughly six percent a year, so the new law would factor in
the decline rate to provide a new rate of one hundred ten
percent (Opex variable cost with declining volumes, p. 8,
copy on file). He maintained that the Department of Revenue
is showing a smaller decline which would effectively change
the unit costs per year from one hundred ten percent in 2007
to one hundred three percent in 2008 and to one hundred five
percent in 2009 (Opex variable cost with declining volumes,
p. 9-10, copy on file).
9:59:14 AM
Mr. Dickinson speculated on increasing volumes that may
occur during facility sharing. He proposed that new
producers would send oil for processing to existing
production facilities, causing an increased flow beyond the
facilities own field production. The variable and fixed
costs, without cap, will end up costing the new producer
more money (Variable costs without cap, p. 11 and Fixed
costs with cap, p. 12, copy on file). He concluded that the
state will receive more money and existing facilities will
be held harmless but the new producer will not see any
benefit which causes them concern.
10:04:10 AM
Senator Elton questioned the presumption that the $10,000
reimbursement received by the facility operator really means
anything. He inquired how the $17,000 figure was obtained.
He pointed out that this being a negotiable figure, the
facility operator could still make a profit using an even
lower figure. Mr. Dickinson agreed with Senator Elton that
this is a capital charge, negotiated by the facility. The
fixed cost is negotiable but the variable costs are not. He
remarked that in the short term, it is possible to move with
the incremental costs but if fixed or capital costs are
never recognized then it will be harder to convince the
facility to make additional investments. He elaborated that
the problem concerns letting the owner of the facility make
a "fair" return for their original investment; the "fair"
amount is the negotiated money with the new producer. He
observed the facility owners may chose not to provide the
use of their facility to new producers plus complications
occur when older wells produce smaller amounts of oil than
the newer wells.
10:08:20 AM
Mr. Dickinson pointed out that the new producer would
provide money to the older facility as a reward for backing
out the production of their less efficient wells. He
reported the bottom line for the old producer would be to
raise the price to about $1.70 for every $1 the facility
owner receives. The net effect is that operating expenditure
costs are variable and, when the cap is put on, variable
costs are treated like fixed costs. He reported if the
facility incurs new costs processing to the new producer, it
can not be deducted. He observed that negotiations between
the new producers and the older producing facilities can
become burdensome as the operating expense limit will result
in higher prices for the new producer.
10:10:05 AM
Senator Elton suggested it would be helpful to have the
Department of Revenue provide information on the new
expected production prior to the sunset date. Senator Dyson
commented that much of the pressure concerning the gross tax
or standard deduction was trying to limit the gaming of the
system. He believed that the standard deduction with a
limited life would entice the major facilities to produce
the wells with the higher gross operating revenue and the
least maintenance costs for this period to the sunset. He
observed many opportunities available to "game" or "tilt"
the system in their favor. Mr. Dickinson agreed that with a
set of rules in place, it would be the goal of the oil
company's tax departments to minimize their tax and reward
the shareholders. He observed this can create new and
specific opportunities in the next three years.
10:12:14 AM
Senator Dyson observed that it was in everyone's interest to
have new producers and explorers gain access to spare
capacity. He remarked that the owner of the facilities could
hold any new production hostage with the negotiated rate. He
questioned if information exists regarding other world-wide
oil fields being able to serve both the public interest and
the small producers without causing a disproportionate
disadvantage to existing facility owners who invested all
the money. Mr. Dickinson agreed but observed that existing
facilities are also trying to maximize their income. If the
facility makes more money processing someone else's oil,
they will do that to try and receive the maximum returns on
their investments. Mr. Dickinson remarked that the Alaska is
unique or "disadvantaged" in that costs are not fixed or
variable but "lumpy." Flexibility is not always available on
the North Slope to maximize or move around equipment or a
station. Mr. Dickinson indicated that if the amount of
production falls off more dramatically then the facility's
ability to handle it, the result is excess capacity.
10:16:21 AM
Senator Dyson responded that there could possibly be a
longer term strategy on the part of the facility owners to
"starve" the smaller companies. He noted the new companies
may not have the cash resources to hang on for ten years or
obtain cash resources to build alternative ways. Senator
Dyson believed that the older facility could prevent these
new producers from selling their oil forcing the company
into an uncomfortable financial situation or forcing
bankruptcy. At this point, the facility would be in a
position to pick up these leases at bargain rates. Mr.
Dickinson agreed it was a valid argument but most of the new
companies arriving in the North Slope were bettered
capitalized and it really benefited no one if they failed.
10:17:50 AM
Mr. Dickinson presented an analysis of the two approaches of
looking at the numbers. He compared the actual 2007 costs
with the derived 2007 allowance and projected the effect at
the end of the cap with comparison between 2009 and 2010 (SB
242 Kuparuk & Prudhoe Units Opex, p. 15, copy on file). He
cautioned the Committee to remember that the numbers are
averages and aggregates and therefore missing individual
items. He explained that the whole point of having a net tax
is that individual things make a difference; there is a
distinction between more and less expensive items. Mr.
Dickinson pointed out that on January 31, 2008, returns were
required to be filed for December 2007 which now gives
twelve monthly returns to discern the amount of operating
expenses filed. This number can be compared to the number
generated with the one hundred thirty seven percent number
claimed for 2006. He remarked that the monthly filings by
taxpayers are not always consistent on how much or what
information is reported, so the information may not be
readily accessible. Mr. Dickinson elaborated that if just
one company in each of the two units clearly defined their
costs and it is assumed these were the only costs allowed by
the unit, then a fair number could be derived. He cited that
the Department of Revenue believes this data remains
confidential. The Committee, in order to compare the actual
higher or lower costs, would need to go into an executive
session to look at the documents (SB 242 Kuparup & Prudhoe
Unites Opex, "One third done", p. 17-18, copy on file). Co-
Chair Stedman commented that an executive session was being
discussed with the Commissioner.
10:20:59 AM
Mr. Dickson remarked that based on first half of the year
the "as-filed" actual operating expenses, before the law
passed, came within three per cent of what was allowed as
the cap. If the three per cent works for the entire year,
then this looks at roughly $2 billion in costs (plus or
minus $60 million) which results, at a twenty five per cent
tax rate, to $15 million in taxes. Senator Elton questioned
the accuracy of these figures. He wondered if the $15
million is what has been filed or what will be paid in the
future. Mr. Dickinson agreed that there is some ambiguity
and that no one knows what to file. He remarked for the
costs not covered in the three percent rule, the Department
of Revenue has to write the rules and regulations and until
they are written no one know what to file. Co-Chair Stedman
inquired if this was the lease expenditure amendment.
10:23:43 AM
Mr. Dickinson observed that a second way to get to the
number is to project what will happen in 2010. He referred
to the graph showing the operating costs claimed. The upper
line represents Kuparuk and Prudhoe Bay and the bottom line
represents everything else (What would we expect between
2009 and 2010 for allowable opex?, p. 20, copy on file). He
explained that the Department of Revenue forecasts show that
in 2009 the numbers will be depressed but in 2010 they
should rise again. He pointed out that further projections
were available to read (What would we expect between 2009
and 2010 for allowable opex?, p. 21-25, copy on file). Mr.
Dickinson concluded that in the final analysis, the
Department of Revenue does not see a significant difference
between the three percent cap and the company filing
"actuals."
10:26:12 AM
Co-Chair Stedman felt it was important for the Senate
Finance Committee to reflect on many of the earlier
discussions, look at expectations on where operating
expenses are going, the rate change, and finally, what is
driving them. He recognized that the Committee must work
with the Department of Revenue on these issues to get the
best estimates available. He suggested that it will be
necessary to explore what new fields are emerging with
capital costs shifting over to operating costs.
10:28:54 AM
Mr. Dickinson referred to slide twenty-four pointing out
that the first column refers to the North Slope operating
expenses as estimated by the Department of Revenue for FY
2007 through FY 2011 (What would we expect between 2009 and
2010 for allowable opex?, p. 24, copy on file). The second
column relates the three percent rule as applied to the
North Slope through 2011 and the third column gives the
implied increase operating expense in areas outside of
Kuparuk and Prudhoe. Mr. Dickinson remarked that it is hard
to tie the numbers together in a consistent fashion.
10:30:54 AM
SB 242 was HEARD and HELD in Committee for further
consideration.
ADJOURNMENT
The meeting was adjourned at 10:33 AM
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