Legislature(2003 - 2004)
03/28/2003 01:05 PM House RES
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 61-OIL & GAS TAX CREDIT FOR EXPLORATION/DEV CHAIR FATE announced that the next order of business would be HOUSE BILL NO. 61, "An Act establishing an exploration and development incentive tax credit for persons engaged in the exploration for and development of less than 150 barrels of oil or of gas for sale and delivery without reference to volume from a lease or property in the state; and providing for an effective date." Number 1687 REPRESENTATIVE MASEK moved to adopt CSHB 61(O&G). There being no objection, it was so ordered. Number 1720 REPRESENTATIVE MIKE CHENAULT, Alaska State Legislature, sponsor, characterized HB 61 as a bill that would create a new income tax credit to encourage increased exploration and development of natural gas resources in areas south of the Brooks Range. To qualify for the [income tax credit] under HB 61, he explained, operators must successfully drill and develop reserves that produce natural gas for sale and delivery. One modification made in the House Special Committee on Oil and Gas, included in CSHB 61(O&G), was the deletion of any reference to oil. This [bill] is strictly dealing with gas issues. Saying "new gas" was [better defined], he paraphrased from page 3, lines 22-26, which read in part: (1) "qualified capital investment" means a cash expenditure or binding payment agreement, as described in (b)(1) of this section, for real property or tangible personal property used in this state in the exploration and development of gas reserves in a gas reservoir for which there has not been commercial production if the reserves produce gas for sale and delivery Number 1781 REPRESENTATIVE CHENAULT said [this legislation] is a "successful efforts bill," which means no credits will be given for dry holes. He suggested that the Cook Inlet area continues to have great potential for additional natural gas development, and that other Alaska basins outside the North Slope have a similar potential. However, he said, a combination of exploration risks, high development costs, and historically low natural-gas prices have created a disincentive to drill for new reservoirs as compared with other areas of the world. REPRESENTATIVE CHENAULT told members that if credit is provided for successful efforts, more exploration will occur in southern Alaska, leading to much-needed new natural gas reserves. This will be a benefit to all residents and businesses at no direct cost to the state, he suggested. In addition to the benefit of developing new gas reserves, increased drilling in Cook Inlet also will aid the general economic status of the Kenai Peninsula, Anchorage, and other areas of the state. Moreover, increased tax revenue from additional gas production will more than offset any fiscal impact from the proposed credit, he said. Number 1885 REPRESENTATIVE MASEK turned attention to the fiscal note provided by the Department of Revenue (DOR). She cited a section of the analysis that read, "Corporations could use their tax credits under this legislation to reduce taxes paid to the state for North Slope production or production from elsewhere in the state." She asked about the impact on current North Slope producers. REPRESENTATIVE CHENAULT, in response, suggested the question could be better answered by someone with DOR. He said, to his knowledge, that certain corporations now work on the North Slope but don't really have any holdings south of the Brooks Range that they're currently drilling. He suggested DOL could better [determine] whether that would have an effect. Representative Chenault also suggested that all corporations probably have leases in Cook Inlet and other areas of the state and the North Slope. He indicated the possibility that the bill could [impact current North Slope producers]. However, he clarified that this tax [credit] is not [intended] for gas reserves on the North Slope; rather, it's for reserves developed south of the Brooks Range. REPRESENTATIVE MASEK asked for clarification from DOR. Number 2034 CHUCK LOGSDON, Chief Petroleum Economist, Tax Division, Department of Revenue, responded: Yes, ... in fact, it's the activity that generates the credit, and if a corporation did have production on the North Slope or was engaged in activities that generated income tax on the North Slope, and they also began to explore and develop in the Cook Inlet, to the ... extent that they produced and sold natural gas, to the extent if they spent enough money in the inlet, such that their only limit would be their total income in Alaska ... or 50 percent of their total corporate liability in Alaska, which would, of course, include income tax liability from North Slope operations. So, ... we're not saying that necessarily would happen, but that it could happen. REPRESENTATIVE MASEK turned attention to another section of DOR's fiscal note, which read, " Oil and gas corporate income tax collections in FY 2003 and FY 2004 are currently projected at $160 million and $200 million per year, respectively." Number 2156 JOHN A. BARNES, P.E., Alaska Business Unit Manager, Marathon Oil Company ("Marathon"), came forward to provide a presentation on why Marathon believes the bill is needed. Referring to a handout in packets, he noted that [page 2 of the handout] talks about what does. He told members: As was mentioned, it creates an income tax credit for exploration development of gas reserves south of the Brooks Range. I'd just like to stress that even though the focus is on the Cook Inlet, there are other basins in Alaska that may have gas potential. And this incentive would also apply to exploration efforts in those areas. Again, the focus is on natural gas. A key point ... is that these are the types of efforts that level the playing field in drawing capital into the state of Alaska from other opportunities that companies may have around the world. ... That is the goal, to draw more capital to the Cook Inlet, ... in context to the other comment about other basins, to draw potentially more capital to the state of Alaska. The next slide [page 3 of the handout], talking a little bit more detail about how the bill works: it would apply to 10 percent of qualified capital investment. It would apply to 10 percent of the qualified expenses that were associated with putting that capital investment to work. It would offset no more than 50 percent of corporate income tax in any one year, but it could be carried over for five additional years. It only applies to successful efforts, as was stated; it would not apply to dry holes or other work. Number 2274 MR. BARNES referred to [page 4 of the handout] and continued: And finally - this is important from the industry side - it could be factored into project economics when you understand weighing investment opportunities in the state of Alaska versus other opportunities. This is a robust, easily identified factor that could be measured. Why is it needed? First, natural gas reserves have been and are continuing to decline in the Cook Inlet. The current Cook Inlet proven reserve base is about 2 ... tcf [trillion cubic feet] ... on mixed units; 2 tcf is about 2000 bcf [billion cubic feet]. Those of you that talk about North Slope gas, it's smaller than that; I wish it was that big. These numbers are based on the DNR [Department of Natural Resources], [Division] of Oil and Gas, 2002 report. Finally, ... despite recent increases in Cook Inlet activity, the reserves are not being replaced on an annual basis. ... If you don't replace reserves annually, your reserve base will go down. Number 2317 On the next slide [page 5 of the handout], I'll talk a little bit about the impact of not replacing reserves. This slide shows the Cook Inlet proven reserves; that's gas that you know is in place through production and other geologic testing. In 1990, there was about three and a half tcf of gas, and in '95, '96, to '97 there were recalculations done. This is not the result of new work; it's just new estimates of the reserves increased ... to a higher level in '97; then they've continued to decline until 2002, in which I reported they were about two tcf or the 2000 bcf. Next slide [page 6 of the handout], ... why is House Bill 61 needed? Cook Inlet deliverability has declined over the last several years. Deliverability is the ability to pull gas out of the ground. It's the rate at which you can produce gas. Number 2363 MR. BARNES continued: Next slide [page 7 of the handout] talks about Cook Inlet peak supply-and-demand requirements. The Cook Inlet is blessed for a lot of reasons. One is it gets very cold in the winter, and because of that you use a lot of gas to heat your homes and provide light. Seasonally, that swing can be about a factor of 3 to 1 between summer heating needs and winter needs. In 1997, the Cook Inlet deliverability, the production capacity, which is shown in red on this exhibit, was about 900 million cubic feet a day, and the total requirements [were] somewhat less than that. During the interim, since that time in 2003, Marathon estimates Cook Inlet deliverability of production capacity at about 667 million cubic feet a day, and that falls below the total requirements that the inlet sees. Number 2407 Next slide [page 8 of the handout], further as to why is it needed, what are the consequences of these points I've tried to make, supply and demand rationalization is occurring: there's not enough gas to feed the low price consumer. That's represented by that deficit between requirements and deliverability, and the gas price is increasing. That's, again, supply and demand. At the current time, ENSTAR's weighted average cost of gas - or WACOG, which is the price that they purchase the gas for, not what they sell it to the consumer - is about 255 per million cubic feet. More recent ENSTAR contracts have been signed at prices that range from $2.75 per mcf [thousand cubic feet] up to Henry Hub. And many of you have seen different reports of Henry Hub gas prices, they go up and down a lot, but recently they've been over $9 an mcf, [and for a] few moments, even higher than that. Number 2457 MR. BARNES continued: Looking ahead on the next slide [page 9 of handout], the Cook Inlet reserves and resources: as I've said, reserves represent gas that you know you have in the ground; resources are gas volumes that you believe are there but have not yet been proven up through the drill bit. The current proven reserve base - as I've said, 2,000 bcf - represents about 10 years of production if you assume that you have no decline in the rates, that you can get it out of the ground, which is not actually a valid assumption. The potential gas committee, which represents various professionals, have estimated Cook Inlet resources - again, those are the reserves that have not yet been discovered - at about 1,050 bcf; that's probable reserves. And then, even riskier, these are reserves that have probably less than [a] 20 or 25 percent chance of being there at about 2,100 bcf. The point of that is that there is potential in the Cook Inlet and there is a reason to continue to explore in the inlet and probably in other basins around the state. Number 2518 What are the impacts to the State of Alaska [page 10 of handout]? First, we believe that it will stimulate activities in the Cook Inlet, and we would hope that it would stimulate activities in other basins as well. We believe it would aid in maintaining the Cook Inlet's current 200-plus-bcf-per-year production. That's what's required to service all needs in the Cook Inlet. Just to the point of reference, that 200 bcf in a year: if you convert that on an energy basis to an oil basis, that represents about 33 million barrels of oil, which is about a thirteenth month of production off the North Slope. So, in world standards, it's a pretty good volume of energy that's being produced. What does it do? It provides gas for the Cook Inlet utilities, the "industrials" that are present, jobs, royalties, and taxes. Number 2557 MR. BARNES continued: Next slide [page 11 of handout]: I'd like to talk a little bit about potential fiscal impacts to the State of Alaska. And I think as it's been stated, ... it may be hard to measure, but we believe that they would be clearly positive to the State of Alaska. ... The things you need to look for when you try to understand what is the fiscal impact and measure it, you have to ask yourself how many developments will be incentivized that might not have happened otherwise: how much gas will ultimately be discovered, what's that volume that you've found, what will that gas sales price be. And the effect of that is what the state sees on royalties and severance tax, obviously. How much will be spent for exploration and development: that's not only, obviously, the measure of the incentive, but it also represents [money spent] in jobs in ... Alaska. To begin, it's successful- efforts-driven: unless gas is found and developed and produced, no incentive will be applied. Number 2610 MR. BARNES continued: Next slide [page 12 of handout]: I've tried to put together a conceptual estimate of the impact. ... I've [listed] ... six assumptions, and they're open for discussion if other professionals or economists would like to look at it, but I varied the field size from 0 to 500 bcf. I looked at a development cost of about 50 cents per mcf, which is a good cost - we're not always that effective - royalty, [12.5] percent; severance tax, [7.5 percent]; ad valorem taxes, just based on sort of an average 2.7 percent. Then I used a $2.50 gas sales price, which is at or near that weighted average cost of gas. Number 2642 The next slide's columns of numbers [page 13 of handout]: I'll just go ahead and briefly go across, and then graphically it's shown on an additional exhibit. If you were to talk about a 50-bcf discovery, the second row in the table, the producing company would probably spend $25 million to develop it; the tax cut would be about [$2.5] million. The total revenue that would be generated at that $2.50 sales price would be $125 million. Royalties that the state would receive if the state had the entire leasehold would be $15.6 million; it would receive about $9 million in severance tax ad valorem, which goes not only to the state but to the local borough - about $1 million. So, the total tax take under this set of assumptions would be about $26 million, which is about the same as the investment cost that was spent to develop it. The other thing to note, though, is that it's about 10 times the tax credit. So, it looks like, under this set of assumptions, there's about a 10-to-1 return to the state, ultimately, if the efforts are successful. Number 2705 MR. BARNES continued: The next slide [page 14 of handout] just graphically shows the same data. I've increased field size on the bottom from 0 to 500 bcf, and you can see the top two cost curves, the development costs, the little reddish squares, then the total tax take, which is just above that, the blue line, and then below that are the different components, and you can see ... near the bottom of the yellow line, [it] represents the tax credit. ... Based on this conceptual model subject to discussion or other assumptions, obviously, the total tax take from one field, which was incentivized, there's a couple ways to look at it; one proposition would be that it pays for the credit for 10 other fields or that the state receives 10 times that revenue. So, I really don't know how you'd want to measure that. ... We believe the credit's needed now; there's not enough exploration currently in the Cook Inlet to meet the demands that are there. Just as a point of fact, if you do have a new discovery, it will probably take a minimum of three years to get first gas production on. Number 2768 MR. BARNES continued: Last slide [page 16 of handout]: what are the success measures, what I think we ought to look for to determine if this credit was successful. I would want to believe that you'd see increased lease activity. The State of Alaska's done a very good job on their areawide lease program, but maybe we'd see ... additional leasing. I would hope to see additional drilling rig activity, ... the activity that counts the most. Subsequent to discovery is construction activity and, ultimately, increased production and deliverability. And, finally, the credit's applied to the income tax. And for every dollar of credit, approximately 10 dollars were spent developing new reserves, and I think that's a good measure. There's been discussions and questions in other meetings about impact on the ... income tax that oil and gas currently contributes to the state. One way to look at it would be, if you had a $10- million credit applied, that the state saw a $10- million reduction. The other thing would be to recognize that 10 times that amount - $100 million - had been spent successfully developing new oil and gas reserves, and Marathon's suggestion would be that that's probably a pretty fair way to look at it. Thank you for your time. I'm available for questions or as required. Number 2831 CHAIR FATE, upon determining that no one else wished to testify, closed public testimony. CHAIR FATE turned attention to some proposed amendments that would be offered. [Typed on one page, the amendments used brackets to delete language and underlining to add language.] He said one has to do with the retroactivity: there was a retroactive date that which would allow this type of credit to start or to have started; with concurrence of the industry, that date was moved ahead, so this credit won't begin to take place for a couple of months, to preclude any question of "double dipping." Chair Fate characterized the remainder of the [proposed amendments] as corrections and cleanup language. Number 2900 REPRESENTATIVE MASEK moved to adopt Amendment 1, which read [original punctuation provided]: Page 2, Line 6 Delete "December 31, 2002" [December 31, 2002] June 30, 2003 There being no objection, it was so ordered. Number 2927 REPRESENTATIVE MASEK moved to adopt Amendment 2, which read [original punctuation provided]: Page 3, Line 11 exploration and development of [oil or] gas There being no objection, it was so ordered. REPRESENTATIVE MASEK addressed Amendment 3, which read [original punctuation provided]: Page 3, Line 19 The expenditures [that support claims for investment tax credits] authorized under.... REPRESENTATIVE KERTTULA asked for clarification. CHAIR FATE indicated the purpose is to tighten the language up. Number 2973 REPRESENTATIVE MASEK turned attention to page 3 of the bill, lines 17-20, subsection (h), which read: For purposes of determining allowable credits under this section, the department shall allow only expenditures and payments that are not inconsistent with the expenditures that support claims for investment tax credits authorized under 26 U.S.C. (Internal Revenue Code) for exploration and development of natural resources. TAPE 03-19, SIDE B Number 2982 REPRESENTATIVE MASEK pointed out that Amendment 3 deletes from it the following: "that support claims for investment tax credits". Number 2976 REPRESENTATIVE KERTTULA expressed concern that those may be two different things: expenditures that support claims for investment tax credits are expenditures brought forward to support those claims, whereas expenditures for exploration and development of natural resources seem to be quite a bit broader. MR. BARNES explained that under the U.S. tax code there currently aren't investment tax credits; thus Representative Kerttula was identifying something that no longer existed. Number 2934 REPRESENTATIVE MASEK moved to adopt Amendment 3 [text provided previously]. There being no objection, it was so ordered. Number 2923 REPRESENTATIVE MASEK moved to adopt Amendment 4, which read [original punctuation provided]: Page 4, Line 31 and Page 5, Line 1 Eliminate the entire Retroactivity clause There being no objection, it was so ordered. Number 2904 REPRESENTATIVE MASEK moved to report CSHB 61(O&G), as amended, out of committee with individual recommendations and the accompanying fiscal notes. There being no objection, CSHB 61(RES) was reported from the House Resources Standing Committee.
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