Legislature(2003 - 2004)
04/24/2003 03:16 PM House O&G
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 198-ROYALTY REDUCTION ON CERTAIN OIL Number 0463 CHAIR KOHRING announced that the next order of business would be SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 198, "An Act providing for a reduction of royalty on certain oil produced from Cook Inlet submerged land." CHAIR KOHRING, sponsor of SSHB 198, explained that he'd been approached by people who own and operate facilities in Cook Inlet, where most platforms were constructed in the 1960s. Production is declining significantly; two facilities out of thirteen have been mothballed, and others may be shut down because they aren't economically feasible. He told members that the intent is to help those platforms specifically. This bill provides a royalty break on those platforms if their production drops below 1,200 barrels a day. It lowers the state's royalty share, now 12.5 percent, down to as low as 5 percent, on a sliding-scale basis. If production were 750 barrels a day or less, for example, it would be 5 percent, and it would rise approximately 1 percent for every additional 100 barrels, up to the 12.5 percent. CHAIR KOHRING offered the expectation that with this provision, production on those platforms would be extended up to an additional 14 months. He called upon Mr. Carlson of Forest Oil Corporation, who he indicated had requested the legislation. Number 0789 GARY CARLSON, Senior Vice President, Forest Oil Corporation, noted that his corporation has been a major investor in Cook Inlet for five years. He told members his testimony would focus on the maintenance of critical and scarce infrastructure associated with mature oil fields in Cook Inlet. He said: Platforms, associated pipelines, and related onshore facilities represent irreplaceable infrastructure which may facilitate the exploration, discovery, and development ... of as-yet undiscovered reserves if their useful lives can be extended. Any delay in abandoning or ... decommissioning of this infrastructure will provide opportunities to the industry to develop smaller-scale oil and gas prospects that won't stand the economics if new infrastructure needed to be developed. As the mature fields approach [the] end of their economic life, the operators need to get creative and manage costs carefully, which [includes] changes in the way they operate and the need for cooperation with their vendors and contractors to share in these efforts. I believe that it is ... appropriate for the state to step in as a partner also. This bill provides a way for the state to do its part. Keeping the current Cook Inlet oil fields on line a few more years will maintain good jobs, provide local taxes and the possibility of new development that could easily exceed the anticipated future shortfall in state revenues resulting from any reduction of the state's royalty. I want to commend the chair and Representatives Rokeberg and Chenault for their leadership on this bill, and to the administration for supporting their efforts. Number 0902 REPRESENTATIVE HOLM asked whether Mr. Carlson maintains that in order to use the resource to its final depletion, it is in the state's best interest to lower the royalty [so companies like his can continue to pump oil economically]. He also mentioned current versus future technology that may allow extraction more economically and thus provide better value for the resource. MR. CARLSON replied: I think the key to keeping interest by the operators in maintaining this infrastructure and continuing to operate it would be to fully understand what their costs are going to be. And some of those costs are associated with personnel and logistics, but some of them are actually ... the money that's pulled off the top and given to the state as a result of ... the state's ownership. MR. CARLSON suggested that extending the life of these platforms may help develop other possible projects; if additional work or discoveries occur from the platforms, their lives can be extended and there will be a higher recovery. He suggested the formula devised by the state in the bill protects the state's interests; if for some reason the rates from these depleting platforms were to increase, the royalty would return to 12.5 percent. He pointed out that Forest Oil Corporation isn't currently an operator of any of these facilities, but is active in Cook Inlet and very concerned about losing infrastructure that may be available to bring new discoveries to another platform, instead of having to build platforms to accept further production. Number 1095 REPRESENTATIVE HOLM said he isn't knowledgeable enough about this area to know where the law of diminishing return comes into play. As a legislator, he offered his belief that it is his fiduciary responsibility to try to protect the state's resources and extract the highest value possible, keeping in mind the desire to retain the producers as partners in order to extract them expeditiously. He pointed out that the fiscal note intimates that the State of Alaska will lose $2.5 million in proposed royalty payments over the next five or six years, and questioned the urgency of this action. Number 1171 MR. CARLSON responded that he believes maintaining that infrastructure and keeping the fields producing - for what could be one to three years, depending on what can be done to maintain the rate - could easily offset the fiscal note estimate. If there were a discovery that only could be developed by using some of that infrastructure, he suggested the return to the state would be many times that amount. Number 1318 CHAIR KOHRING conveyed his belief that encouraging the continued production of these facilities creates potential for the state to generate even more money in the future because these existing facilities represent millions of dollars' worth of critical infrastructure from which further exploration can be done in the future. Even though there is no guarantee, there is that potential to use these facilities to engage in directional drilling and find additional oil reservoirs. MR. CARLSON concurred. With regard to urgency, he said one platform has been shut in, and another is scheduled for that soon; therefore, he feels there is a sense of urgency to do something before it's too late. CHAIR KOHRING asked Mr. Myers, in addition to his testimony on behalf of the division, to address Representative Holm's concerns and whether the amount lost will be gained in other ways. Number 1356 MARK MYERS, Director, Division of Oil & Gas, Department of Natural Resources (DNR), advised members that a key goal for "incentivizing" oil and gas ought to be looking at incentives that are efficient and effective, and that hopefully are direct and measurable. He offered his belief that SSHB 198 meets those criteria. He explained that the Cook Inlet platforms have been producing for a long time; the state has a lot of good data, a good understanding of the reserve base, and a good understanding of the productions costs. In that light, he said, when the thresholds for royalty reduction were chosen, [DNR] worked carefully with data from Union Oil Company of California (Unocal) and Forest Oil Corporation, as well as internal data including DNR data and Department of Revenue (DOR) data that could be shared. MR. MYERS said this was modeled accurately, using long-term production trends. Two different trends were found with regard to when the economic limit for particular platforms is reached. Thus there are two clusters of platforms. The first has platforms where the wells produce lots of water that must be separated out and that use significant water flood. They have more expensive operating costs and, therefore, an economic threshold of production such that operating costs exceed the value of the oil production; more barrels [of oil] are needed to justify their operating costs. The second has platforms that have a limited amount of water and water handling, and little water injection; those have cheaper costs. MR. MYERS told members the bill therefore was designed by looking at those factors and at clustered fields. Appropriately, it lists individual fields, but it's truly based on economic clusters of data, not just targeting those particular fields. He said it was easier to name the fields, but those fields represent certain characteristics of production and inherent reservoir characteristics. Number 1491 MR. MYERS remarked that this is a case when it can be argued that royalty reduction is a very appropriate mechanism to extend field life. He went on to say royalty reduction is generally asymmetrical and explained, "Because your production is declining from the field, the period of time in which you ... actively affect the economics of the field and bring it up on line - when you're only talking about a 7.5 percent differential in the amount of production - is limited." He also pointed out that if the desire is to use this as an incentive to keep production going longer and possibly to get additional investment in the platforms, the relief should be given slightly before it is absolutely, critically needed. He added, "Plus, then, you're projecting on certain oil prices to project the economic threshold." Number 1532 MR. MYERS continued: We used a pretty middle-of-the-road calculation for netback oil price and then ran a bunch of scenarios ... on the platform, and came up with this cluster of data. So we feel pretty good that our fiscal [note] accurately reflects the loss in royalty, which, again, we think is relatively small. ... The first year, it's about $220,000, going up to nearly $600,000 in 2007. Those are relatively small numbers compared to the value of that infrastructure. One of our concerns is, once you start pulling out multiple platforms out of the inlet, there's a synergy between the platforms. There's piping that goes between the platforms. There's common use of onshore facilities. All those additional costs of rerouting those pipes for existing platforms ... would cause additional costs, as well as a lesser throughput to those existing production facilities on shore would raise the cost. ... There's an interlinked interdependency of facilities in the inlet, and we want to make sure as much of that [as possible] keeps producing as long as it can. Number 1585 MR. MYERS expressed optimism about the exploration potential and said: We know of multiple prospects that exist off these existing platforms, and sometimes a current operator isn't desirable of expending the money to do the exploration, but a new operator might. So we're buying time ... in case there's sale or trade [of] the platforms, et cetera - other opportunities. So while we lose some direct revenue, it's very quantifiable. It's relatively minimal on the scale of the potential benefit of that infrastructure, and we're hoping that the upside does exist. In the meantime, you have preserved jobs and you have preserved that oil going to the refineries ... on the Kenai [Peninsula], which are important to the state's economy. Number 1622 REPRESENTATIVE McGUIRE asked how 5 percent was arrived at. MR. MYERS answered that there's an historical precedent for using 5 percent, which the state uses for discovery royalty. It's in existing statute for six fields in Cook Inlet that weren't producing. It also leaves enough direct economic benefit to the state. If it's set much lower or at zero, then the fiscal note becomes bigger. He offered his belief that 5 percent royalty isn't a substantial burden on the project. "We might extend it a few months more by going lower, but this is a good number," he added. MR. MYERS also pointed out that if these numbers don't work, an applicant [can seek] royalty reduction under the current royalty reduction statute; that can go down to 3 percent and is based on need, using technical data. He also mentioned royalty reduction under HB 28 if that bill passes. He added that this [5 percent in SSHB 198] is a "pretty good, standard threshold, we feel, that we still are getting direct revenue from the platforms as well as we're affecting the economics." Number 1726 REPRESENTATIVE CRAWFORD asked what happens to platforms after they get shut in. For example, can they be reconditioned and shipped elsewhere? MR. MYERS answered that it is uncharted territory as to what the state would do. Initially, production would be suspended; there are a few platforms where that has happened. He further explained: Initially, that would just be plugging back the wells, cleaning the surfaces, keeping, usually, a manned presence or in some cases unmanned, if they go to a total cleaning and monitoring system. And then there's a period of time. At some period of time where there really isn't any additional economic potential, then the wells will be cemented in via AOGCC [Alaska Oil and Gas Conservation Commission] requirements, permanently abandoned, and the facility will have to be abandoned. ... That process of what is done with the facility is truly going to be a public process, with multiple agencies looking at it and, I assume, with stakeholder influence from ... all sorts of other outside, nongovernmental organizations. The "highest and best use" question, I think, will really be put there: Do you want to keep the facility there? ... Can it be reused? There are certainly options to cut the legs off of the platforms if you bring in a (indisc.), move it over to another facility. ... So there's potential to use them. There's potential for various dismantlement and [removal], actually ... moving them out of the inlet, et cetera. So, to the extent of the final abandonment requirements for a platform, we haven't gone there yet. It is something the state will have to face in the future. And certainly DNR will play a role in that, but other agencies will as well. The federal Coast Guard navigation issues will occur, et cetera. You can get a long list ... of potential actions that would have to be taking place. Number 1830 MR. MYERS continued: We're studying the issue. We sent some folks to a conference in California - where they're looking at abandoning some offshore platforms - the MMS [Minerals Management Service] sponsored. So we have models to go by from the federal [government] and ... folks in the Gulf of Mexico and offshore California. So we're looking [at] that, but we have not yet totally integrated what needs to be done. Number 1852 MR. MYERS, in response to Representative Kerttula, indicated the fields listed in the bill are the older, existing platforms, rather than newer fields like Redoubt Shoals. He added that there is one onshore field, West McArthur [River] field, and said, "It's onshore facilities but offshore fields." He said although all the fields are named, the bill isn't designed to be name-specific, but is an easier, simpler way to look at the actual characteristics and economic criteria. "Again, we found the data clustered nicely around two types of platforms," he added. "And when you use a general bill like this, unless you wanted to [have] specific royalty reduction for each platform, you had to use ... an amount." He concluded by saying that the names are there because it targets certain characteristics, and that it is inclusive of all those platforms in Cook Inlet that have those characteristics. Number 1938 REPRESENTATIVE FATE asked what the average daily production was at midlife for these fields. MR. MYERS said he didn't know, but estimated perhaps 15,000 to 20,000 barrels a day; he suggested Mr. Carlson might have those figures. At the peak, Cook Inlet production was an order of magnitude larger than it is now, he said. "So we're really down near the end, ... and Redoubt Shoals, of course, is a great success, and that's going to help bring us up," he added. Mr. Myers said there is some other exploration going on; the hope is that it will lead to new production to substantially revive the inlet. Except for that, however, these platforms and reservoirs are largely expended. He pointed out that one challenge for companies is that they'll spend the money to drill a directional well; if successful, they may increase production, but it's marginal. "If this tips the scale, we'll all benefit," he concluded. Number 2025 REPRESENTATIVE FATE referred to [AS 31.05] and recalled looking at royalty reduction specific to Cook Inlet a year ago, with the idea of perhaps broadening it statewide, for example, and making it self-limiting with a sunset date. He asked whether this current bill "will stimulate the kind of exploration for more oil in that area, which will take advantage of this royalty reduction, above and beyond what we thought it would." MR. MYERS responded: We have multiple programs, but I think the program we're referring to is the discovery royalty program, which gives 5 percent royalties to new discoveries. This program, I guess, is more certain, because you have all the production data. So this extends the life of infrastructure; that greatly improves the economics of future exploration. So I think this is actually ... one of our more positive moves that's clearly a direct, effective incentive, and will, ... if explorers are out there, ... give them more opportunity and more time. This buys us time with existing infrastructure, ... because once some of this infrastructure goes away, it's not going to be replaceable ... unless they find very large accumulations, which increases exploration risk because they need to find very large fields, then, to build ... the infrastructure in the inlet. Generally, in the inlet, to put a new platform, people typically need probably around ... 30 or 40 million barrels of recoverable reserves. So you need a pretty substantial discovery for the inlet, though certainly the prospects are there to find more of those. But when you chance-risk it, it's nice if that number goes down a little bit because there's an existing platform for development. ... If you could use an existing platform, you might save a lot of money on the development, in which case, then, your limit for exploration size might shrink down by 5 or 10 million barrels, leaving you to drill a lot more different types of prospects, or lowering your risks. Number 2134 MR. MYERS emphasized the synergies. He said one of Cook Inlet's real advantages is the existing infrastructure, which probably results in a much higher netback per barrel than on the North Slope. He added: We want to keep that advantage there with this existing infrastructure. And, again, that will get more people drilling. We've seen a lot of good "independent action," as you've seen, particularly on the gas side, with independents in the inlet. There may be some swapping of platforms or selling of platforms, we hope, in the future with folks that might be a little more aggressive on exploration, say. MR. MYERS concluded by saying this is truly a very good, direct incentive because "we can quantify the amount, and we can see the direct effects of it." Number 2174 CHAIR KOHRING expressed appreciation to Mr. Myers for his work on the legislation and for working with the owners of the platforms on this. Number 2197 MR. MYERS informed the committee of the following [technical changes] needed in the bill. On page 2, line 2, he said the phrase "field or" should be removed because it is specific to those platforms. On page 3, line 7, "XTO.B" should read "XTO.C". On page 3, subparagraph (E) is talking about a field in this one case; therefore, "platform" should be deleted on line 26 and replaced with "field", and the words "or platform" should be removed on line 29. Number 2272 REPRESENTATIVE HOLM moved to adopt the foregoing as a [conceptual] amendment. There being no objection, it was so ordered. Number 2287 REPRESENTATIVE FATE moved to report [SSHB 198, as amended] out of committee with individual recommendations and the accompanying fiscal note(s). There being no objection, CSSSHB 198(O&G) was reported from the House Special Committee on Oil and Gas.
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