Legislature(2023 - 2024)ADAMS 519

04/16/2024 01:30 PM House FINANCE

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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ HB 393 COOK INLET/MIDDLE EARTH GAS ROYALTIES TELECONFERENCED
Heard & Held
*+ HB 307 INTEGRATED TRANSMISSION SYSTEMS TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
HOUSE BILL NO. 393                                                                                                            
                                                                                                                                
     "An  Act relating  to oil  and gas  leases and  royalty                                                                    
     shares; and providing for an effective date."                                                                              
                                                                                                                                
2:30:26 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE TOM  MCKAY, SPONSOR, explained that  the bill                                                                    
related to  Cook Inlet  and Middle  Earth gas  royalties. He                                                                    
mentioned  recent  discussions  regarding  gas  storage.  He                                                                    
related that  he had  introduced a  package of  energy bills                                                                    
that  roughly  formed  an  energy   plan.  He  reminded  the                                                                    
committee that Cook  Inlet was an isolated  and mature basin                                                                    
with  a  "hybrid  closed  market and  a  limited  amount  of                                                                    
consumption at  70 Billion Cubic  Feet (BCF) per  year." Any                                                                    
amount  higher than  70 bcf  needed to  be stored.  He added                                                                    
that importing  LNG was not  anticipated until 2030,  and it                                                                    
would need  storage as well.  He believed that gas  that was                                                                    
not developed  did not benefit  anyone and HB 393  was meant                                                                    
to  incentivize more  gas production.  He  read the  sponsor                                                                    
statement (copy on file):                                                                                                       
                                                                                                                                
     In  the  coming  years,  Southcentral  Alaska  faces  a                                                                    
     critical  challenge:  a  projected shortage  and  ever-                                                                    
     increasing decline  in Cook Inlet gas  production. This                                                                    
     looming  shortage poses  a  significant  threat to  the                                                                    
     energy  security of  our state,  with the  potential to                                                                    
     lead  to drastic  increases in  energy  prices for  the                                                                    
     residents  and businesses  of Southcentral  Alaska. The                                                                    
     prospect  of diminishing  in-state gas  supplies and  a                                                                    
     reliance  on liquefied  natural gas  (LNG) imports  not                                                                    
     only threatens our economic stability  but also our way                                                                    
     of life.                                                                                                                   
                                                                                                                                
     Due  to the  nature of  this issue,  bold and  decisive                                                                    
     action is  required. HB 393 makes  a significant change                                                                    
     to the Cook  Inlet royalty structure based  on the idea                                                                    
     that  the Inlet  is  not  attracting enough  investment                                                                    
     dollars  and activity  for development  and exploration                                                                    
     drilling. At this critical  juncture, royalties on Cook                                                                    
     Inlet  gas which  decrease drilling  activity, increase                                                                    
     the  cost  of  gas,  or  lead  to  costly  LNG  imports                                                                    
     represent a tax on  southcentral ratepayers in addition                                                                    
     to jeopardizing the energy security of our state.                                                                          
                                                                                                                                
     This legislation  seeks to address the  anticipated gas                                                                    
     production  shortfall by  decreasing  royalty rates  on                                                                    
     new  wells for  gas used  by Alaskans  to 0%,  with the                                                                    
     goal  of fostering  an environment  which will  lead to                                                                    
     increased  drilling and  exploration activities  in the                                                                    
     Cook  Inlet region.  This bill  also  reduces the  base                                                                    
     royalty on wells currently producing  to 5%, which will                                                                    
     extend  the life  of those  wells leading  to more  gas                                                                    
     production.  HB  393   extends  incentives  to  "middle                                                                    
     earth" and allows drilling and  development costs to be                                                                    
     deducted against royalty  burdens. The rationale behind                                                                    
     HB  393   is  straightforward:  by   enhancing  project                                                                    
     economics, we can attract  more investment into natural                                                                    
     gas   exploration   and  production.   This   increased                                                                    
     investment will  not only  mitigate the  risk of  a gas                                                                    
     shortage  but  also  has  the  potential  to  stabilize                                                                    
     energy prices for Southcentral Alaskans.                                                                                   
                                                                                                                                
     HB 393 is  an acknowledgment of the  critical role that                                                                    
     affordable and  reliable energy plays in  our lives and                                                                    
     a  recognition  of the  need  for  immediate action  to                                                                    
     secure our energy  future. I urge my  colleagues in the                                                                    
       rd                                                                                                                       
     33   Alaska State Legislature to join  me in supporting                                                                    
     HB 393.                                                                                                                    
                                                                                                                                
2:36:33 PM                                                                                                                    
                                                                                                                                
TREVOR JEPSEN,  STAFF, REPRESENTATIVE MCKAY,  introduced the                                                                    
PowerPoint presentation  HB 393 Cook Inlet/Middle  Earth Gas                                                                    
Royalties" dated April 16, 2024  (copy on file). He began on                                                                    
slide 1 titled "Cook Inlet Production Shortage                                                                                  
                                                                                                                                
    State is facing a looming and increasing shortage of                                                                     
     Cook Inlet natural gas production.                                                                                         
                                                                                                                                
   Legislature has tools at its disposal via legislation                                                                     
     to address Cook Inlet gas production.                                                                                      
                                                                                                                                
    No "silver-bullet" solution.                                                                                             
                                                                                                                                
The  slide  also  contained a  bar  graph  depicting  proved                                                                    
developed  and proved  undeveloped  Cook  Inlet Gas  through                                                                    
2041. Mr.  Jepsen elaborated that  declining Cook  Inlet gas                                                                    
production was  expected to lead  to a supply  shortage from                                                                    
the 70  bcf standard  necessary for Southcentral  Alaska. He                                                                    
pointed out that  the blue section of  bar graph represented                                                                    
proven reserves  and the orange portion  was expected proved                                                                    
undeveloped reserves. The shortage  was anticipated to begin                                                                    
in 2027. However,  the shortage would develop  over a period                                                                    
of  15 to  20  years.  The impacts  of  importing LNG  would                                                                    
significantly increase  energy costs  affecting the  cost of                                                                    
living  beyond  Southcentral  Alaska and  possibly  increase                                                                    
outmigration  from  the  state.  He  believed  that  current                                                                    
decreasing worker retention rates  would be exacerbated, and                                                                    
state and  municipal government  budgets would  increase due                                                                    
to increased fuel  costs. He voiced that  royalty relief was                                                                    
the "most immediate and impactful  tool at the legislature's                                                                    
disposal and passage of the bill was "crucial."                                                                                 
                                                                                                                                
Mr. Jepsen continued  on slide 2 titled  "Poll Results: What                                                                    
Do Alaskans Want:"                                                                                                              
                                                                                                                                
    High level of support (59%) for state incentives to                                                                      
     private companies and utilities to identify and pursue                                                                     
     projects to ensure energy deliverability.                                                                                  
                                                                                                                                
   Same support (59%) for creating financial incentives                                                                      
     for oil and gas companies to find and produce more                                                                         
     Cook Inlet gas.                                                                                                            
                                                                                                                                
   Significant opposition to importing natural gas (72%)                                                                     
     with 44% having "strong" opposition.                                                                                       
          Most common reason for opposition: "there is                                                                          
          plenty of gas, we're a resources state, we just                                                                       
          need to get the gas." (46%)                                                                                           
                                                                                                                                
      "Importing gas is more expensive" only cited by                                                                           
          18% of  respondents.                                                                                                  
                                                                                                                                
    If residents were convinced imports are the cheapest                                                                     
     option could be a sizeable shift in support, up to                                                                         
     60%.                                                                                                                       
                                                                                                                                
    87% of residents support the construction of a natural                                                                   
     gas pipeline for in-state use and export ; evenly                                                                          
     divided on the idea of reducing the PFD to help fund a                                                                     
     gas line (40 percent support/49 percent oppose.                                                                            
                                                                                                                                
Mr.  Jepsen expounded  that HB  393 responded  to the  "high                                                                    
level  of support  for financial  incentives regarding  Cook                                                                    
Inlet  gas  production."  He indicated  that  the  bill  was                                                                    
predicated on the  idea that gas produced in  Cook Inlet was                                                                    
used   by  Alaskans   and  high   royalties   acting  as   a                                                                    
disincentive   or  leaving   gas   undeveloped  leading   to                                                                    
importing  LNG acted  as  a "tax  on  Alaskans." Mr.  Jepsen                                                                    
continued  on   slide  3   titled  "Market   Dynamics"  that                                                                    
contained a  graphic depicting a hypothetical  scenario that                                                                    
did  not represent  exact volumes  and prices.  He explained                                                                    
that proven developed reserves were  the least expensive gas                                                                    
to  produce and  the least  costly to  the consumer.  Moving                                                                    
right on the  graphic to discovered but  undeveloped gas was                                                                    
more costly  and drove  up gas prices.  He moved  further to                                                                    
the   right  that   depicted  undiscovered   reserves  where                                                                    
production   was  significantly   more   expensive  due   to                                                                    
exploration and development costs.  He shared that according                                                                    
to  the Department  of Natural  Resources  (DNR) there  were                                                                    
hundreds of bcf  of discovered and undiscovered  gas in Cook                                                                    
Inlet.  He offered  that changes  to  royalties lowered  net                                                                    
costs  to  the  producers  and pass  through  costs  to  the                                                                    
consumers  and  increased  project economics.  However,  the                                                                    
royalty  relief  must  be   sufficient  to  produce  desired                                                                    
results.                                                                                                                        
                                                                                                                                
2:42:26 PM                                                                                                                    
                                                                                                                                
Representative Hannan  inquired about  the poll on  slide 2.                                                                    
She  asked for  the date  the poll  was conducted,  the poll                                                                    
size, and poll geography; statewide or Railbelt only.                                                                           
                                                                                                                                
Mr.  Jepsen responded  that the  number of  participants was                                                                    
402  resulting in  a  95 percent  confidence  interval of  5                                                                    
percent  plus or  minus a  margin of  error. The  population                                                                    
size was  representative of the  share of the  population in                                                                    
Southcentral.  He offered  to provide  the exact  geographic                                                                    
distribution  of poll  respondents. The  poll was  taken the                                                                    
prior summer.  Representative Hannan remarked that  the poll                                                                    
seemed   broader   She  asked  who paid  for  the poll.  Mr.                                                                    
Jepsen  affirmed that  the poll  was broad  based. He  added                                                                    
that it  was conducted by  Dittman Research and paid  for by                                                                    
Enstar.                                                                                                                         
                                                                                                                                
Representative Stapp  cited Mr. Jepsen's statement  that the                                                                    
royalty represented  a tax  on all  Alaskans. He  asked what                                                                    
the  current royalty  on  North Slope  gas  was. Mr.  Jepsen                                                                    
replied  that  it  was 12.5  percent.  Representative  Stapp                                                                    
asked  who paid  for the  royalty  on North  Slope gas.  Mr.                                                                    
Jepsen  was uncertain.  Representative Stapp  explained that                                                                    
the Interior Gas Utility (IGU),  in Fairbanks had a contract                                                                    
with Hilcorp  through a Hilcorp subsidiary  called "Harvest"                                                                    
to  truck  Liquefied  Natural  Gas  (LNG)  to  the  Interior                                                                    
beginning  in October  [2024].  He noted  that  it was  full                                                                    
royalty gas. He  asked if Mr. Jepsen considered  that "a tax                                                                    
on  all Alaskans  paying  for royalty  on  gas for  domestic                                                                    
use." Mr.  Jepsen answered  that he considered  it a  tax on                                                                    
Fairbanks  residents and  "probably should  not be  assessed                                                                    
either." He shared  that Rep. McKay was of  the opinion that                                                                    
royalty  on   gas  used  by  Alaskans   represented  a  tax.                                                                    
Representative Stapp  asked for  Mr. Jepsen to  elaborate on                                                                    
the following bullet point from  slide 2, "If residents were                                                                    
convinced  imports  are  the  cheapest  option  could  be  a                                                                    
sizeable shift  in support,  up to  60 percent."  Mr. Jepsen                                                                    
responded that  it was  related to  the question  of support                                                                    
for  importing natural  gas that  had 72  percent opposition                                                                    
unless it was the cheapest option.                                                                                              
                                                                                                                                
2:46:02 PM                                                                                                                    
                                                                                                                                
Representative   Josephson  understood   that  one   way  to                                                                    
incentive production  was to reduce royalties.  He cited the                                                                    
statement  that royalties  were "a  tax on  the consumer  by                                                                    
implication."  He   deduced  that   it  [royalties]   was  a                                                                    
contributor  to  costs but  was  "the  ownership share."  He                                                                    
asked  if  he  was  correct.   Mr.  Jepsen  replied  in  the                                                                    
affirmative.   Representative  Josephson   stated  that   it                                                                    
[royalties] was "linked to the  Permanent Fund (PF) corpus."                                                                    
He  recalled  that during  "the  oil  tax debates  over  the                                                                    
previous decade" the slogan "it's  our oil" was displayed by                                                                    
some  who wanted  "a more  progressive  tax" structure  with                                                                    
greater benefits  to state treasury.  He countered  that the                                                                    
only  part that  remained  the state's  share  was the  12.5                                                                    
percent royalty  and believed that  it was  "effectively our                                                                    
remaining mineral  right." He  asked whether  his assessment                                                                    
was correct. Mr. Jepsen answered in the affirmative.                                                                            
Representative   McKay  interjected   that   "only  if   the                                                                    
hydrocarbon  gets produced."  He added  that it  contributed                                                                    
nothing to the  PF if it was  never produced. Representative                                                                    
Josephson offered that  in a range of options  as a solution                                                                    
it [royalty relief] "would be  on the list." However, it was                                                                    
not  a guarantee.  He asked  if the  governor's version  [HB
276-Reduce  Royalty   on  Cook   Inlet  Oil  and   Gas]  was                                                                    
comparable. Representative McKay  responded that nothing was                                                                    
guaranteed.  He  offered  that the  provision  acted  as  an                                                                    
incentive  for  the  private  sector   to  produce.  He  had                                                                    
multiple discussions  with the  private sector  partners and                                                                    
concluded  that  HB  393  would   result  in  increased  gas                                                                    
production in  Cook Inlet. He  believed that when  oil taxes                                                                    
increased projects  were cancelled,  and industry  jobs were                                                                    
cut. He  intuited that the  opposite effect would  happen if                                                                    
taxes  were lowered.  Representative Josephson  was troubled                                                                    
by contradictory statements regarding  the importance of the                                                                    
state's  "mineral  interests  and  that it  was  the  people                                                                    
money" who were  entitled to it versus  viewing royalties as                                                                    
an  imposition on the people and  a penalty on them" and was                                                                    
viewed   negatively.  He   could  not   reconcile  the   two                                                                    
arguments.                                                                                                                      
                                                                                                                                
Mr.  Jepsen   interjected  that  he  viewed   the  issue  as                                                                    
significantly  different than  the oil  on the  North Slope,                                                                    
which he characterized as a  "global commodity" that was not                                                                    
typically utilized in the state.  Conversely, Cook Inlet gas                                                                    
was used  solely by  Alaskans. He was  not advocating  for a                                                                    
royalty  reduction   of  North  Slope   oil.  Representative                                                                    
Josephson asked  how the bill  differed from  the governor's                                                                    
version. Mr.  Jepsen responded that the  governor's bill was                                                                    
rolled  into  HB  223-Oil/Gas   Royalty  Rates;  Cook  Inlet                                                                    
Develop,   sponsored  by   Representatives  Rauscher   as  a                                                                    
compromise  between  the  two bills   royalty  package.  The                                                                    
legislation confined  the royalty  reduction to  "new pools"                                                                    
that were  either never produced or  had stopped production.                                                                    
House  Bill  393 made  no  distinction  but offered  a  zero                                                                    
royalty rate for all new gas pools drilled.                                                                                     
                                                                                                                                
2:51:16 PM                                                                                                                    
                                                                                                                                
Representative   Josephson  deduced   that  the   governor's                                                                    
proposal was  less "generous"  as to  previous developments.                                                                    
He asked for affirmation.  Representative McKay responded in                                                                    
the affirmative  and added that  his legislation  was easier                                                                    
to administer.  He believed  that it  would be  difficult to                                                                    
measure old gas  and new gas and  apply different royalties.                                                                    
His legislation applied a zero  royalty to all gas produced.                                                                    
Representative  Josephson   understood  that   DNR  assessed                                                                    
different royalty rates on different  fields all the time on                                                                    
the North Slope. Representative  McKay agreed but would need                                                                    
to defer  to the  Department of Revenue  (DNR) for  an exact                                                                    
answer.                                                                                                                         
                                                                                                                                
2:53:02 PM                                                                                                                    
                                                                                                                                
DAN  STICKEL, CHIEF  ECONOMIST, DEPARTMENT  OF REVENUE,  TAX                                                                    
DIVISION (via  teleconference), confirmed that  the question                                                                    
pertained  to  royalty and  how  DNR  accounted for  varying                                                                    
royalties  on the  North Slope.  He acknowledged  that there                                                                    
were  different leases  with different  royalties within  an                                                                    
existing  field.   He  reported   that  DNR  had   a  robust                                                                    
methodology on how it was  calculated. He explained that DOR                                                                    
applied the tax to the oil  and gas that was left over after                                                                    
accounting  for the  royalties.  The  department's role  was                                                                    
simpler than DNR's process. He  disclosed that some areas of                                                                    
the  tax code  distinguished  between old  and  new oil  and                                                                    
those   provisions  were   on   a   field  specific   basis.                                                                    
Representative Josephson surmised that  DNR had the capacity                                                                    
to make the differentiation.                                                                                                    
                                                                                                                                
Representative Galvin wondered why  the bill would propose a                                                                    
royalty  give  away  if  gas  was  already  being  produced.                                                                    
Representative McKay answered that he  did not like the word                                                                    
"give  away"  and  believed  that  it  implied  a  "sinister                                                                    
motive."  He reiterated  that  the bill  was  an attempt  to                                                                    
incentives all  gas production  in Cook  Inlet from  new and                                                                    
existing wells.  He characterized  HB 393 as  aggressive and                                                                    
said that all gas production would be incentivized.                                                                             
                                                                                                                                
Mr. Jepsen added  that the reason for  the royalty reduction                                                                    
for producing wells was that  the cost of operating the well                                                                    
exceeded the  cost of production  and was "shut in"  at some                                                                    
point in time. He indicated  that some Cook Inlet wells were                                                                    
shut in too early because the royalty rate was too high.                                                                        
                                                                                                                                
Representative Galvin understood  the economic justification                                                                    
and  thought  it "made  sense."  She  relayed from  a  prior                                                                    
committee  hearing   on  the  importance   of  incentivizing                                                                    
heavier  on  the  early years  of  production  as  companies                                                                    
drilled  new oil  or gas  fields. She  asked how  many years                                                                    
royalty would  be dropped. Mr.  Jepsen responded  that there                                                                    
was  no sunset  provision. Representative  Galvin asked  why                                                                    
there  would not  be  a sunset  clause if  the  goal was  to                                                                    
incentivize new gas development.                                                                                                
                                                                                                                                
2:58:40 PM                                                                                                                    
                                                                                                                                
Representative McKay  responded that he  would be open  to a                                                                    
sunset.  He explained  that gas  wells  often declined  more                                                                    
rapidly than  oil wells and  most gas wells would  need more                                                                    
economic help within  10 years. He determined  that a future                                                                    
legislature could revisit a sunset  date if it was added. He                                                                    
relayed that  he had been  asked why the  problem reappeared                                                                    
after  a  solution  was  implemented   10  years  prior.  He                                                                    
discerned from his  experience that it would  not be unusual                                                                    
to reevaluate  and adjust  as necessary  every ten  years as                                                                    
the life  of a gas  field changed over  time. Representative                                                                    
Galvin   inquired   as   to   who   evaluated   the   wells.                                                                    
Representative  McKay explained  what  stripper  wells  were                                                                    
(wells making 5 barrels a day  for 20 years or more or wells                                                                    
with  significantly reduced  production  but  were still  in                                                                    
operation) as an analogy to  Cook Inlet. He believed that as                                                                    
long  as  the  economics  of   Cook  Inlet  gas  fields  was                                                                    
monitored, Cook Inlet  gas could keep producing  for "a very                                                                    
long  time." Representative  Galvin understood  that royalty                                                                    
was  a  contractual term  in  the  lease  and could  not  be                                                                    
changed  by future  legislators. She  asked whether  she was                                                                    
correct. Representative McKay responded  in the negative and                                                                    
commented that  a future legislature  could take  any action                                                                    
regarding  royalties. He  reiterated  that his  goal was  to                                                                    
extend the life of Cook Inlet.                                                                                                  
                                                                                                                                
3:03:25 PM                                                                                                                    
                                                                                                                                
Representative Josephson believed that  it was prohibited to                                                                    
increase a royalty  rate and that it could  only be adjusted                                                                    
downward temporarily.  He referred  to Mr.  Jepsen's comment                                                                    
that Cook Inlet wells were  shut in because the royalty rate                                                                    
was too high. He countered  that there were many reasons why                                                                    
shut ins  occurred and the  royalty rate being too  high was                                                                    
only  one reason.  Representative McKay  responded that  the                                                                    
situation was referred to as  a "lifting cost." He explained                                                                    
that lifting costs was the cost  it took to pump the oil and                                                                    
gas out of the ground and  get it to market. He hypothesized                                                                    
that if gas prices collapsed  reducing the profit margin, it                                                                    
could  eventually  cause  shut  in  wells  due  to  economic                                                                    
conditions.  In addition,  any  scenario  where labor  costs                                                                    
increased  or  shipping  tariffs increased,  etc.  added  to                                                                    
lifting  costs. He  acknowledged that  there were  many cost                                                                    
factors that  affected lifting costs and  when lifting costs                                                                    
exceeded the price the wells could be shut in.                                                                                  
                                                                                                                                
Representative  Josephson  inquired  whether  the  producers                                                                    
could request royalty relief under  existing law. Mr. Jepsen                                                                    
answered in the  affirmative. Representative Josephson asked                                                                    
whether  any  Cook  Inlet  producers  asked  for  a  royalty                                                                    
reduction. He  recalled that Cook  Inlet provided  the state                                                                    
$40 million  annually in royalties.  He asked how  the state                                                                    
would  deal with  the foregone  revenue  and provide  agreed                                                                    
upon services with less revenue.                                                                                                
                                                                                                                                
Representative McKay  replied that there would  be an impact                                                                    
on  the General  Fund (GF)  and the  PF. He  noted that  the                                                                    
[revenue] impact  on the budget  and PF from Cook  Inlet was                                                                    
"minimal" compared  to the North  Slope. He relayed  that he                                                                    
received  an analysis  about what  would happen  to consumer                                                                    
energy  rates  based on  increases  in  natural gas  prices,                                                                    
which had  a "significant impact" on  consumer energy costs.                                                                    
He asked Mr. Jepsen to relay the data.                                                                                          
                                                                                                                                
Mr. Jepsen maintained that the  impact on the rate payer was                                                                    
significantly higher  than the  $40 million in  lost revenue                                                                    
to the state.                                                                                                                   
                                                                                                                                
Co-Chair Foster  interjected that the discussion  touched on                                                                    
many different  policy areas,  and he  wanted to  finish the                                                                    
presentation before further policy debate.                                                                                      
                                                                                                                                
3:09:02 PM                                                                                                                    
                                                                                                                                
Mr. Jepsen  continued on slide 4  titled "Considerations for                                                                    
Energy Policy:"                                                                                                                 
                                                                                                                                
    Short Term vs. Long Term.                                                                                                
                                                                                                                                
     Risk vs. Cost State needs to decide what level of                                                                       
     risk is acceptable.                                                                                                        
                                                                                                                                
    Higher-Cost energy = Lower Risk Options.                                                                                 
                                                                                                                                
    Lower-Cost Energy = Higher Risk Options.                                                                                 
                                                                                                                                
    How policies interact.                                                                                                   
                                                                                                                                
Mr. Jepsen  elaborated that  risk to  the state  referred to                                                                    
revenues  to  the state  via  royalties.  A higher  cost  of                                                                    
energy via  importing LNG  was a  lower risk  option because                                                                    
the state was  not losing royalties. In  addition, the state                                                                    
had  the capability  to  store  LNG in  Cook  Inlet. It  was                                                                    
highly likely the  state would be ready to  import and store                                                                    
LNG before  a gas shortfall.  The higher risk option  to the                                                                    
state in terms  of foregoing royalties was  focused on lower                                                                    
cost energy for residents and  increasing the supply of Cook                                                                    
Inlet  gas. Increased  imports of  LNG  meant higher  energy                                                                    
prices  for  residents  for  years  to  come.  He  suggested                                                                    
considering  how policies  interacted with  one another  and                                                                    
whether policies  were complimentary.  He concluded  that HB
393  represented a  high risk  option which  resulted in  an                                                                    
immediate  decrease in  royalty  revenues to  the state  but                                                                    
with the  goal of  increasing production  and the  supply of                                                                    
low cost energy to residents  that works in conjunction with                                                                    
other legislation incentivizing Cook Inlet investment.                                                                          
                                                                                                                                
Mr. Jepsen continued to slide 5 (untitled):                                                                                     
                                                                                                                                
     The Case for Aggressive Royalty Reduction                                                                                  
                                                                                                                                
          •Cook Inlet represents a small share of the                                                                           
          state's oil and gas revenues.                                                                                         
                                                                                                                                
          •Energy prices likely to double or triple in the                                                                      
          next 15 years if mass LNG imports are the                                                                             
          solution.                                                                                                             
                                                                                                                                
          •An increase of this magnitude would result in                                                                        
          rate payers paying 100's of millions to billions                                                                      
          more in energy costs every year.                                                                                      
                                                                                                                                
Mr. Jepsen reported that the  slide also included a table of                                                                    
oil and gas revenue by type  and geographic area, FY 2020 to                                                                    
FY 2023. Mr.  Jepsen explained that the  slide represented a                                                                    
rough fiscal  impact on  the state  from royalty  relief. He                                                                    
elucidated that  the chart illustrated  that the  state made                                                                    
billions from the  North Slope compared to  tens of millions                                                                    
from  Cook Inlet  in a  given fiscal  year. The  state would                                                                    
lose approximately  $45 to  $60 million  per year.  He noted                                                                    
that if  the state  did nothing  Cook Inlet  royalties would                                                                    
decrease   over   two   decades   as   production   dropped.                                                                    
Southcentral utilities  made roughly over $1  billion in the                                                                    
prior  year with  $250 million  of Enstar's  profits derived                                                                    
from gas  sales while  70 to 80  percent of  other utilities                                                                    
profits came  from gas power  electricity. He  surmised that                                                                    
the risk from  lost state revenue was worth  the reward. The                                                                    
impact on  the rate payer  was not capped like  royalties of                                                                    
$45  million to  $60 million  per  year on  Cook Inlet  gas,                                                                    
which carried the specter of very large rate increases.                                                                         
                                                                                                                                
3:13:10 PM                                                                                                                    
                                                                                                                                
Mr. Jepsen  continued on slide  6 titled  "Royalty Structure                                                                    
Modifications                                                                                                                   
                                                                                                                                
Market  has   spoken:  Cook  Inlet  under   current  royalty                                                                    
structure is not ideal for investment                                                                                           
                                                                                                                                
Time Value of Money                                                                                                             
                                                                                                                                
What does the state want to incentivize?                                                                                        
                                                                                                                                
     Royalty and tax decreases on producing wells                                                                               
         Extend the life of existing wells.                                                                                  
                                                                                                                                
      Royalty and tax decreases on new wells                                                                                    
         Increase the number of wells drilled.                                                                               
                                                                                                                                
Mr.  Jepsen voiced  that  the  rates of  return  on gas  was                                                                    
"significantly"  lower  than  oil." He  summarized  that  by                                                                    
greatly reducing  royalties, it boosted the  rates of return                                                                    
for producers  that made projects more  viable. He disclosed                                                                    
that  an additional  policy  included in  the  bill was  not                                                                    
accessing   royalties   until    payout,   which   was   the                                                                    
recuperation of costs  for oil and gas  development, both in                                                                    
Cook Inlet and Middle Earth,  defined as south of 68 degrees                                                                    
latitude  (excludes  the  North Slope).  He  expounded  that                                                                    
allowing  investors or  companies to  recoup its  costs more                                                                    
quickly  was  another way  to  quickly  recover its  initial                                                                    
investment costs.                                                                                                               
                                                                                                                                
Mr. Jepsen continued to slide 7 titled "HB 393 Overview                                                                         
                                                                                                                                
    Changes royalty structure for Cook Inlet:                                                                                
                                                                                                                                
          0% for gas produced from new wells drilled                                                                            
          starting in FY 25.                                                                                                    
                                                                                                                                
          5% for oil produced from new wells drilled                                                                            
          starting FY 25.                                                                                                       
                                                                                                                                
          5% on oil and gas produced from wells drilled                                                                         
          prior to FY 25.                                                                                                       
                                                                                                                                
    Capital expenditures associated with development of                                                                      
     oil or gas can be deducted from royalty burden;                                                                            
     Excludes North Slope.                                                                                                      
                                                                                                                                
    Requires commissioner to enter into lease negotiations                                                                   
     to comply with these terms.                                                                                                
                                                                                                                                
3:16:21 PM                                                                                                                    
                                                                                                                                
Representative Stapp pointed to  the second bullet point and                                                                    
asked whether it  included Cook Inlet and  Middle Earth. Mr.                                                                    
Jepsen  responded in  the affirmative.  Representative Stapp                                                                    
asked  if the  royalty is  zero and  the production  tax was                                                                    
near zero,  what was being  deducted from taxes.  Mr. Jepsen                                                                    
responded that  there would  nothing to  be deducted  and it                                                                    
could  not  be  deducted below  zero.  Representative  Stapp                                                                    
asked what  capital lease  expenditures were  being deducted                                                                    
against  since  essentially  royalties and  taxes  were  not                                                                    
being paid.  Mr. Jepsen  replied if  there was  zero royalty                                                                    
and  no  tax  burden  there  would  be  nothing  to  deduct.                                                                    
Representative  Stapp  asked  whether  new  wells  would  be                                                                    
drilled in Cook Inlet in FY  25 regardless of passage of the                                                                    
bill.   Mr.    Jepsen   responded   in    the   affirmative.                                                                    
Representative Stapp asked if it  was a fair assessment that                                                                    
zeroing  out  the  royalties  on new  wells  that  would  be                                                                    
drilled regardless of the bill  and applying that across the                                                                    
board would incentivize new  production. Mr. Jepsen answered                                                                    
in the affirmative. He restated  that it was not possible to                                                                    
target   wells   individually   that  were   being   drilled                                                                    
regardless  of  the  bill's  passage.   He  voiced  that  by                                                                    
decreasing  royalties  to zero  for  all  wells the  sponsor                                                                    
hoped  to attract  new players  to the  Inlet. He  expounded                                                                    
that there  were only  3 producers in  Cook Inlet,  with one                                                                    
producing the vast majority of gas.                                                                                             
                                                                                                                                
Representative  Stapp   wondered whether  there would  be an                                                                    
influx of  new producers  if royalty  rates were  reduced to                                                                    
zero. Representative  McKay would not make  the promise, but                                                                    
anything over zero was  good. Representative Stapp explained                                                                    
that  few people  had been  able  to convince  him that  the                                                                    
policy  was needed  to pursue  new development.  He reasoned                                                                    
that  the  bill implied  that  producers  did not  have  the                                                                    
margin  in  the market  space  to  recoup its  profits.  The                                                                    
natural  inclination  was  to assume  that  Cook  Inlet  gas                                                                    
producers sell  its gas to  consumers at increased  rates to                                                                    
make up  the lack of revenue.  He wondered why it  was not a                                                                    
market demand problem.                                                                                                          
                                                                                                                                
3:20:45 PM                                                                                                                    
                                                                                                                                
Representative  McKay   deemed  that   Representative  Stapp                                                                    
wanted the  state to do nothing  and allow the price  of gas                                                                    
to increase,  which spurred more production  as would happen                                                                    
in a free market. He reported  that he had consulted with an                                                                    
economist regarding that scenario.  However, the problem was                                                                    
that  economists  did  not  have  constituents  and  it  was                                                                    
important that  Cook Inlet and  the Railbelt  had affordable                                                                    
and reliable  energy. He agreed  that the  legislature could                                                                    
do nothing  and let  costs increase,  however, if  they were                                                                    
wrong,  the problem  would get  worse. He  believed that  by                                                                    
acting there would be some  degree of confidence the problem                                                                    
would be solved.                                                                                                                
                                                                                                                                
Representative Stapp  inquired what the current  oil royalty                                                                    
was for Cook Inlet gas.  Mr. Jepsen responded that it varied                                                                    
but   was   mostly   12.5  percent.   Representative   Stapp                                                                    
understood  the gas  concept but  was  unsure what  happened                                                                    
with Cook Inlet oil. Mr.  Jepsen responded that the majority                                                                    
went to the Marathon Oil refinery.                                                                                              
                                                                                                                                
3:23:59 PM                                                                                                                    
                                                                                                                                
DEREK  NOTTINGHAM, DIRECTOR,  DIVISION OF  OIL AND  GAS (via                                                                    
teleconference), responded that the  majority of oil went to                                                                    
the Marathon refinery and believed  the volume of Cook Inlet                                                                    
oil exported was very low.                                                                                                      
                                                                                                                                
Representative Stapp relayed a  prior a dispute in Fairbanks                                                                    
where the  refinery there was  refining the  state's royalty                                                                    
share of the oil.  He referred to Representative Josephson's                                                                    
statement  that royalty  oil was  the state's  share of  the                                                                    
oil. He wondered  what would happen if the  state was taking                                                                    
 our   oil  royalty share  and  giving  it to  Marathon  for                                                                    
domestic  refining and  consumption of  gas. He  asked "what                                                                    
does  that actually  do if  we cut  the royalty  on our  own                                                                    
state oil." Mr.  Jepsen answered that gas  wells produced an                                                                    
associated amount of  oil. The bill was focused  on gas, but                                                                    
if the royalty rate was  decreased on the associated oil the                                                                    
project economics rate of return was further increased.                                                                         
                                                                                                                                
Representative McKay  interjected that  some oil  wells only                                                                    
produced oil and  some gas wells that only  produced gas and                                                                    
some  that produced  both.  Representative Stapp  understood                                                                    
that  gas producers  had contracts  with companies  and when                                                                    
they sell  the gas to  power producers some of  the existing                                                                    
contracts had  state royalty provisions inside  contracts in                                                                    
general. He asked how many  contracts for Cook Inlet oil and                                                                    
gas there were  and if they included  royalty provisions. He                                                                    
inquired  whether  change  in the  royalty  structure  would                                                                    
change  the existing  contract terms  of  the contract.  Mr.                                                                    
Jepsen deferred the answer to Mr. Nottingham.                                                                                   
                                                                                                                                
Mr.  Nottingham  replied  that  he  was  not  aware  of  any                                                                    
provision in the contracts  regarding royalties. He expanded                                                                    
that there  were statutes  that allowed  DNR to  account for                                                                    
the   royalty  value   to  be   at  the   contracted  price.                                                                    
Therefore, the contracted price that  the gas was sold at to                                                                    
the  utilities  was what  the  royalty  value was  based  on                                                                    
opposed to  market value indicators  that was  normally used                                                                    
for North Slope royalties.                                                                                                      
                                                                                                                                
3:28:27 PM                                                                                                                    
                                                                                                                                
Representative Stapp asked how  many wells or if exploration                                                                    
on   state  land   was  taking   place   in  Middle   Earth.                                                                    
Representative  McKay responded  that he  was unsure  of how                                                                    
many  wells but  knew  of  two developments.  Representative                                                                    
Stapp reported  that the fiscal  note stated  that currently                                                                    
there  was no  Middle earth  exploration or  developments on                                                                    
state lands or even expected soon.                                                                                              
                                                                                                                                
3:29:27 PM                                                                                                                    
                                                                                                                                
Representative Hannan referred to Section  2 of the bill and                                                                    
deduced that  no royalties would  be assessed  in perpetuity                                                                    
on any oil  or gas developments anywhere in  the state other                                                                    
than on  the North Slope. She  asked if she was  reading the                                                                    
provision  correctly.  Mr.  Jepsen answered  that  the  zero                                                                    
royalty  on  gas   was  for  Cook  Inlet   and  the  capital                                                                    
expenditure portion  of the  bill was  for Middle  Earth. In                                                                    
addition, the royalty for oil was 5 percent and not zero.                                                                       
                                                                                                                                
Representative  Hannan ascertained  that the  royalties were                                                                    
still  charged   but  just   the  lease   expenditures  were                                                                    
deductible as  an offset. Representative McKay  affirmed and                                                                    
clarified that  it applied  to Middle  Earth. Representative                                                                    
Hannan  emphasized  that  the   bill  specified  it  applied                                                                    
anywhere south  of the North  Slope and not only  Cook Inlet                                                                    
or Middle Earth. She inquired  that if oil was discovered in                                                                    
Juneau  in  20  years  no   oil  or  gas  royalty  would  be                                                                    
applicable.  Representative  McKay  responded  that  he  was                                                                    
trying to help Fairbanks develop its own natural gas field.                                                                     
                                                                                                                                
Mr.  Jepsen interjected  that  the oil  royalty  would be  5                                                                    
percent  and the  gas rate  would  be zero  for Cook  Inlet.                                                                    
Representative Hannan was confused  because it was not clear                                                                    
in   the   bill,  but   she   would   accept  Mr.   Jepsen's                                                                    
interpretation.                                                                                                                 
                                                                                                                                
3:32:00 PM                                                                                                                    
                                                                                                                                
Representative Josephson referenced two  prior major oil and                                                                    
gas bills.  He noted  that HB  247 (Tax;  Credits; Interest;                                                                    
Refunds; O  & G  - Chapter  4 4SSLA  16 -  06/28/2016) ended                                                                    
Cook Inlet  credits and  HB 111 (Oil  & Gas  Production Tax;                                                                    
Payments; Credits Chapter - 3  SSSLA 17 - 07/27/2017), which                                                                    
ended credits and limited  carry forward lease expenditures.                                                                    
He  remarked  that  HB  393's   royalty  reduction  went  in                                                                    
perpetuity  and asked  if there  was a  failure to  produce,                                                                    
could the  producers draw  down capital  costs way  out into                                                                    
the future.  He asked  what would incentivize  production if                                                                    
capital  cost   credits  could  be   earned  at   any  time.                                                                    
Representative  McKay answered  that   almost  all bills  he                                                                    
proposed in the  current session would not  require cash out                                                                    
of the  treasury like the  previous cash credit  programs in                                                                    
the  past.   The  legislation   attempted  to    front  load                                                                    
proposals                                                                                                                       
                                                                                                                                
Mr.  Jepsen  replied that  it  did  not  make sense  that  a                                                                    
producer would make an investment  and not try to recoup the                                                                    
investment. However,  he saw a  scenario of  price decreases                                                                    
as a  possible scenario  where producers  would not  want to                                                                    
sell and  wait to produce.  He offered that   Representative                                                                    
McKay was open to a sunset  but noted that a ten year sunset                                                                    
would not be long enough.                                                                                                       
                                                                                                                                
Representative   McKay  exemplified   that   the  Pika   oil                                                                    
development took  13 years from  discovery to first  oil. He                                                                    
emphasized that  the clock starts  when the  legislation was                                                                    
passed.                                                                                                                         
                                                                                                                                
Representative Josephson  asked if  the legislature  and the                                                                    
administration had done a thorough  enough analysis on rates                                                                    
of return and  project economics and whether  or not current                                                                    
leaseholders  were merely  refusing to  produce even  though                                                                    
their   projects   were   economic.   Representative   McKay                                                                    
responded  that  he  had many  conversations  with  DNR  and                                                                    
directly  asked  whether  Hilcorp   was  meeting  its  lease                                                                    
obligations and  drilling its required  number of  wells per                                                                    
year. He  reported that  the answer to  the question  was in                                                                    
the  affirmative. He  added that  it  was widely  understood                                                                    
that the rate  of return on projects in Cook  Inlet was much                                                                    
less than on the North Slope.                                                                                                   
                                                                                                                                
3:37:53 PM                                                                                                                    
                                                                                                                                
Co-Chair Foster asked for closing comments.                                                                                     
                                                                                                                                
Representative McKay  thanked the  committee and  offered to                                                                    
answer  all  the committee  members  questions  in order  to                                                                    
thoroughly vet the bill.                                                                                                        
                                                                                                                                
HB  393  was  HEARD  and   HELD  in  committee  for  further                                                                    
consideration.                                                                                                                  
                                                                                                                                
Co-Chair Foster reviewed the agenda  for the following day's                                                                    
meeting.                                                                                                                        
                                                                                                                                

Document Name Date/Time Subjects
HB393 Presentation ver. R 4.12.24.pdf HFIN 4/16/2024 1:30:00 PM
HB 393
HB393 Sponsor Statement ver. R 4.12.24.pdf HFIN 4/16/2024 1:30:00 PM
HB 393
HB393 Sectional Analysis ver. R 4.12.24.pdf HFIN 4/16/2024 1:30:00 PM
HB 393
HB 307 Public Testimony Rec'd by 041524.pdf HFIN 4/16/2024 1:30:00 PM
HB 307
HB307 PowerPoint Presentation to HFIN 4.16.24.pdf HFIN 4/16/2024 1:30:00 PM
HB 307