Legislature(2015 - 2016)BARNES 124
03/19/2016 01:00 PM House RESOURCES
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| Audio | Topic |
|---|---|
| Start | |
| HB247 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | HB 247 | TELECONFERENCED | |
| + | TELECONFERENCED |
HB 247-TAX;CREDITS;INTEREST;REFUNDS;O & G
1:00:55 PM
CO-CHAIR NAGEAK announced that the only order of business is
HOUSE BILL NO. 247, "An Act relating to confidential information
status and public record status of information in the possession
of the Department of Revenue; relating to interest applicable to
delinquent tax; relating to disclosure of oil and gas production
tax credit information; relating to refunds for the gas storage
facility tax credit, the liquefied natural gas storage facility
tax credit, and the qualified in-state oil refinery
infrastructure expenditures tax credit; relating to the minimum
tax for certain oil and gas production; relating to the minimum
tax calculation for monthly installment payments of estimated
tax; relating to interest on monthly installment payments of
estimated tax; relating to limitations for the application of
tax credits; relating to oil and gas production tax credits for
certain losses and expenditures; relating to limitations for
nontransferable oil and gas production tax credits based on oil
production and the alternative tax credit for oil and gas
exploration; relating to purchase of tax credit certificates
from the oil and gas tax credit fund; relating to a minimum for
gross value at the point of production; relating to lease
expenditures and tax credits for municipal entities; adding a
definition for "qualified capital expenditure"; adding a
definition for "outstanding liability to the state"; repealing
oil and gas exploration incentive credits; repealing the
limitation on the application of credits against tax liability
for lease expenditures incurred before January 1, 2011;
repealing provisions related to the monthly installment payments
for estimated tax for oil and gas produced before January 1,
2014; repealing the oil and gas production tax credit for
qualified capital expenditures and certain well expenditures;
repealing the calculation for certain lease expenditures
applicable before January 1, 2011; making conforming amendments;
and providing for an effective date."
1:01:09 PM
CO-CHAIR TALERICO moved to adopt the proposed committee
substitute (CS) for HB 247, Version 29-GH2609\P, Shutts,
3/18/16, as the working document.
REPRESENTATIVE JOSEPHSON objected for purposes of discussion.
1:01:57 PM
GARY ZEPP, Staff, Representative Benjamin Nageak, Alaska State
Legislature, on behalf of the co-chairs of the House Resources
Standing Committee, said the proposed work draft is the result
of 20 committee hearings. The committee heard from the Walker
Administration; independent legislative consultants; explorers,
developers, and producers operating in Alaska's oil and gas
industry; representatives of support services organizations; and
the public. These are difficult times for Alaska and for the
oil and gas industry. Alaska has serious budget problems in
light of low oil prices. The oil and gas industry is operating
at losses in Alaska, it costs more to get barrels of oil out of
the ground than is being received for the oil. The co-chairs
recognize Alaska's budget problems and want to support a
balanced resource policy that protects investment, maintains
production, and provides state revenues over the short term and
into the future. The right balance between exploration and
production is critical. The exploration success over the next
three to five years becomes the production for twenty years and
into the future. The revenues support Alaska's government
services. The co-chairs requested and received permission from
Representative Hawker to have Ms. Rena Delbridge assist the co-
chairs and their staff in the technical provisions of this
legislation and to assist the co-chairs and staff in developing
the CS. He said Ms. Delbridge will provide a summary of the
changes and a sectional analysis for the CS.
1:03:50 PM
RENA DELBRIDGE, Staff, Representative Mike Hawker, Alaska State
Legislature, on behalf of the co-chairs of the House Resources
Standing Committee, reviewed the summary of changes included in
the proposed CS, Version P. She explained that overall for the
North Slope, Version P would maintain the existing fiscal system
that was put into place in 2013. Version P would not make
changes to the gross minimum tax or to the tax floor. Version P
would prevent the use of the gross value reduction (GVR) for new
oil from increasing the size of a loss. Version P would provide
that statewide the state can reimburse each eligible company per
year a maximum of $200 million from the oil and gas tax credit
fund. For Cook Inlet and Middle Earth, Version P would reduce
the well lease expenditure credit from 40 percent today, to 30
percent in 2017, and to 20 percent in 2018. For Cook Inlet and
Middle Earth, Version P would reduce the 25 percent net
operating loss credit to 10 percent effective January 1, 2017.
Version P would maintain the current transferability and
refundability options subject to the annual cap of $200 million
per company.
MS. DELBRIDGE explained that Version P would also maintain the
current interest rate on delinquent taxes at three points above
the Federal Reserve rate, which today is an interest rate of
about 4 percent. Version P would change from simple interest to
interest compounding quarterly beginning in 2017. Version P
would ensure that municipal entities that are producers are
eligible for credits only in proportion to the production that
they have that is subject to production taxes; the work draft
would require them to proportion those lease expenditures to the
taxable production. In case of companies with an outstanding
liability to the state related to their oil and gas activity,
Version P would allow the Department of Revenue (DOR) to
withhold the amount of that liability from any repurchase of a
credit certificate. The applicant would be able to authorize
the payment of that liability out of that amount withheld so
that DOR could make that payment on behalf of the taxpayers.
For Cook Inlet, Version P would create a legislative working
group to develop system reform for evaluation by the full
legislature in 2017; this would be a comprehensive review of the
entire Cook Inlet and Middle Earth fiscal systems.
1:06:42 PM
MS. DELBRIDGE reviewed the sectional analysis for Version P.
She said Sections 1-5 provide conforming language that relates
to the repeal in Section 28 of a Department of Natural Resources
(DNR) exploration program that applied pre-2007 [AS 41.09];
those provisions were also in HB 247. She said Section 6, page
3 of Version P, relates to interest and provides that the
interest rate on delinquent taxes remains at the current amount
of 3 percent [three points above the Federal Reserve rate], but
would be compounded quarterly beginning in 2017. Section 7,
page 3 of Version P, provides conforming language related to the
new outstanding liability to the state provisions that are in
Section 17. Section 7 applies to the natural gas storage
facility credit so that the new Section 17 rules would apply to
that credit as well. Section 8 likewise provides conforming to
the new outstanding liability language; it ensures that for the
purposes of the liquefied natural gas (LNG) storage facility
credit, the outstanding liability language in the new Section 17
apply. Section 9 similarly applies the new Section 17
outstanding liability provisions to the in-state oil refinery
infrastructure expenditures credit. Sections 10 and 11 provide
conforming language related to the repeal in Section 28 of the
two Department of Natural Resources exploration credit programs
[in AS 38.05.180(i) and 41.09].
MS. DELBRIDGE explained that Section 12, page 5 of Version P,
makes some of the key changes related to this legislation.
First, for the area south of 68 degrees North latitude, this
section reduces the amount of the carried-forward annual loss
[tax credit] from 25 percent to 10 percent. Second, lines 19-22
on page 6 ensure that the application for a gross value
reduction (GVR) for new oil on the North Slope is not used to
increase the amount of a loss. In regard to Section 13, she
noted that later in this legislation the qualified capital
expenditure (QCE) credit of 20 percent in Cook Inlet is
maintained, but the work draft sunsets that credit with the rest
of the Cook Inlet regime in 2022. The sunset of the QCE and the
well lease expenditure (WLE) credits in Cook Inlet in 2022
results in a great number of reforming sections to this bill.
The current definition of a qualified capital expenditure in
many sections of the tax statute says the definition in the QCE
credit is how a QCE expenditure is defined. So, if the credit
is repealed in 2022, any place where the credits definition is
used means that a new definition must be created and conform
those statutes to that new definition. Section 13 provides
conforming to the change in placement of the QCE definition [in
Section 27] related to the QCE [credit] repeal [in Section 29].
Section 14 provides conforming language to the repeal of the QCE
credit in 2022.
1:10:41 PM
MS. DELBRIDGE said Section 15, pages 7-8 of Version P, is
material in that in Cook Inlet it reduces the well lease
expenditure (WLE) credit from 40 percent to 30 percent beginning
January 1, 2017, and from 30 percent to 20 percent on January 1,
2018. Section 15 also makes a conforming change related to the
repeal of the two DNR exploration credits. Ms. Delbridge
related her understanding that the co-chairmen may in the future
be offering an amendment to this section as it was an oversight
to retain the 20 percent WLE stepdown into 2022. She explained
that the WLE credit is an additional amount of incentive for a
segment of the work that is already covered by the QCE credit.
So, once the WLE credit reaches 20 percent, it is in effect no
different than the QCE credit at 20 percent; the amendment
repeal the WLE credit once it reaches 20 percent and not wait
until 2022.
MS. DELBRIDGE noted that Section 16 is also a material change.
For disbursements from the oil and gas tax credit fund when DOR
purchases a credit certificate, DOR would not be able to
purchase a total of more than $200 million in tax credit
certificates from a single entity per year. She drew attention
to the portion of Section 16 on page 8, lines 29-31, and said
there is concern that a cap per company on the amount of overall
credit refunds that a company can get from the state, could
motivate a company to split into multiple versions of that same
company for the purpose of getting the cap several times instead
of once. This language protects against such splitting by
ensuring that if DOR finds that a single entity has divided into
multiple entities for the purpose of trying to evade this cap
per company, DOR does not need to pay from this fund. The
language is very similar to existing provisions related to the
small producer credit already in statute.
1:13:22 PM
MS. DELBRIDGE specified that Section 17 is the new section
related to outstanding liability. Section 17 provides that if
an applicant seeking refund from the state for a tax credit
certificate has an outstanding liability to the state that
relates to the company's oil and gas activity, DOR may purchase
only that part of a tax certificate that exceeds the outstanding
liability. The effect is that DOR would withhold from refund
the amount that is outstanding in liability somewhere else in
the state. With the taxpayer's consent, DOR can actually use
that withholding to pay off that liability on behalf of the
taxpayer. If the department does that, it is clear in these
lines that that does not affect the applicant's ability to
contest that liability.
REPRESENTATIVE SEATON inquired whether the rest of the tax
credits would still remain transferable.
MS. DELBRIDGE replied that this would only apply to the
refundability. The company would get refunded for the amount
less the liability that it owes.
REPRESENTATIVE CHENAULT asked whether that liability would go
just to liability related to state issues or would it include
any liability, such as a liability to subcontractors,
contractors, or other private corporations that have done
business with the company in question.
MS. DELBRIDGE responded it relates strictly for the applicant's
liability to the state; if a company has an outstanding
liability, something that has been assessed and not been paid,
then that would apply. She said she will get back to the
committee as to how broad that is related to subcontractors.
1:15:41 PM
MS. DELBRIDGE resumed her sectional analysis. She reiterated
that Section 17 allows DOR to pay on behalf of the taxpayer to
another entity and said it also allows the department to enter
into contracts or agreements with other departments in order to
do that. She noted that Section 18 is conforming to the 2022
repeal of the QCE and WLE credits in Cook Inlet. Section 19
conforms to the change in placement of the QCE definition since
the QCE credit would be repealed in 2022. Section 20 conforms
to the change in placement of the QCE definition in relation to
the QCE repeal. Section 21, page 11, of Version P, conforms to
the repeal of AS 43.55.165(j) and (k) in Section 29. These are
sections of statute which include the QCE definition issue;
however, they apply to tax years prior to 2010, so Legislative
Legal and Research Services recommends they be repealed rather
than to change the definitions. Section 22, page 12 of Version
P, also conforms to the change in placement of QCE definition.
Sections 23 and 24, page 15 of Version P, conform to the 2022
repeal of the QCE credit. Section 25 conforms to the change in
placement of the QCE definition related to the 2022 repeal.
MS. DELBRIDGE explained that Section 26, page 16 of Version P,
requires municipalities that are producers to allocate their
lease expenditures and their tax credits between their taxable
and exempt production. The effect is that a municipality would
not receive credits for production that is not subject to
production taxes. Section 27 provides the new definition for a
qualified capital expenditure, which is necessary because of the
repeal of the QCE credit where a capital expenditure is
currently defined. Section 28 repeals two DNR exploration
credit programs. The AS 41.09 credit was sunset in 2007, but
remains on the books. The AS 38.05.180(i) program provides the
authority for DNR to create a credit program, but it was never
created and therefore this is a good time to repeal that.
Section 29 repeals the QCE credit and the WLE credit in January
1, 2022, and repeals AS 43.55.165(j) and (k), which applied
before 2010.
1:19:17 PM
MS. DELBRIDGE specified that Section 30, page 17 of Version P,
creates a legislative working group that is charged with a
thorough analysis of the existing Cook Inlet fiscal regime for
oil and gas. It is tasked with recommending changes to the full
legislature for consideration during the regular session in
2017. It is asked to account for a number of provisions: a tax
structure that looks to the unique circumstances related to oil
versus gas; consideration of all phases of oil and gas activity
from exploration to development and production; consideration of
Alaska's competitiveness in attracting new investors;
consideration of the unique market features, or lack of market
features, related to local energy supply; evaluation of
alternative means of state support for that exploration,
development, and production phases that might not be direct cash
support via credits but may be programs where Alaska Industrial
Development and Export Authority (AIDEA) might be able to
provide some financing or support; evaluation of the need for
public disclosure of some confidential information related to
taxpayers and confidentiality in credits. The working group
would be composed of legislative membership only and would be
led by two co-chairs, one appointed by the speaker of the house
and one by the president of the senate. Those co-chairs would
determine the numbers and needs of the working group. Specific
provisions are provided so co-chairs can create an advisory
group to the working group that would include members who are
not legislators but have expertise to bear on the industry,
fiscal systems, and the unique gas supply issues related to Cook
Inlet. The expectation is that consultants already under
contract through the Legislative Budget and Audit Committee
would be able to support this working group in its activities.
1:21:45 PM
MS. DELBRIDGE said Section 31, page 18 of Version P, provides
applicability language related to the new requirements in
Section 17 for purchasing transferrable tax credit certificates
through the oil and gas tax credit fund. Section 32 provides
transition language for the January 1, 2022, repeal of the QCE
and WLE credits. The effect is to ensure that expenditures
incurred before the repeal date are eligible for the credits
even after the repeal date. Section 33, page 19 of Version P,
provides transition language related to the Section 29 repeal of
AS 43.55.165(j) and (k). Section 34 provides transition
language that would empower the Department of Revenue and
Department of Natural Resources to adopt regulations related to
this bill. Section 35 provides transition language related to
retroactive regulations. Section 36, page 20 of Version P,
provides for an immediate effective date for the legislative
working group and for the authority of DOR and DNR to write
regulations. Section 37 provides a delayed effective date of
January 1, 2022, for the repeal of the QCE credit and the WLE
credit; this applies to sections [13, 14, 18-25, 27, 29, 32, and
33]. Section [38] is an effective date of January 1, 2017, for
all other bill sections.
1:23:31 PM
REPRESENTATIVE SEATON, regarding Section 12, asked what the
effect is of reducing the net operating loss (NOL) credits from
25 percent to 10 percent, but then maintaining the QCE credits.
MS. DELBRIDGE answered that the three aforementioned items are
the three levers to be pulled in Cook Inlet. The co-chairs
looked hard at what degree those levers could be pulled and
still protect the supply of gas for local consumption and to
maintain as much support as possible for current investments
without entering into a situation in which the state's
substantial credit program offers incentive for whole newcomers
to now enter Cook Inlet and undertake new activities that rely
very heavily on this currently high level of 65 percent state
support. The co-chairs had heard clearly from the legislative
consultant, enalytica, that that 65 percent is high for what the
state may be realizing in return for that work. So, the attempt
was to bring the overall state support down. Right now with
these changes after the WLE steps down, it would be up to about
30 percent. The NOL in particular is something that a non-
producer, someone still in that early development stage, may be
looking to. By reducing that, the intended effect is that while
the Cook Inlet regime is examined in 2017 there is a limited
number of newcomers to Cook Inlet that come strictly for the
attractiveness of that credit system. The QCE is work related;
it is for lease expenditures that are happening to develop
production and it is very much a key supporting credit for work
that is currently underway. Likewise, the WLE credit, which is
a super-credit for a certain segment of QCE work, has proven
very helpful in accomplishing the goal of energy security in
Cook Inlet and is used fairly consistently. So the hope is to
stepdown that WLE credit while maintaining that QCE level of
support for that ongoing investment to maintain what is
happening today, and to bring down that NOL lever as well.
REPRESENTATIVE SEATON remarked that he really wants to figure
out the interaction because taking the net operating loss to 10
percent sounds like the state is not interested in anybody else
coming in. He said he wants "to get a very fine definition on
who and what types of companies that maintaining the qualified
capital investment credit relates to instead of them using as a
net operating loss and qualifying that same kind of investment
as ... the net operating loss credit."
1:27:25 PM
REPRESENTATIVE CHENAULT clarified it is Section 38, not 36, that
provides an effective date of January 1, 2017, for all other
bill sections [not included under Sections 36 and 37].
MS. DELBRIDGE confirmed that it is a typographical error on the
last page of the sectional analysis and she will correct it.
1:28:30 PM
REPRESENTATIVE JOSEPHSON, in regard to Cook Inlet, understood
that Version P would reduce the state's outlays to roughly 40
percent effective January 1, 2017, and 30 percent effective
January 1, 2018.
MS. DELBRIDGE requested the question be repeated.
REPRESENTATIVE JOSEPHSON noted the subtraction in the credits is
40 percent effective nine months from now and the credits would
drop to 30 percent by January 1, 2018, from the 65 percent.
MS. DELBRIDGE replied yes, because in 2018 the WLE [credit]
would have been stepped down to 20 percent, so the remaining
credits available would be the 20 percent QCE and the 10 percent
net operating loss.
REPRESENTATIVE JOSEPHSON recalled that the governor's original
proposal would cut the state's deficit by $500 million, and by
some accounts it could be $600 million. He inquired whether it
is Ms. Delbridge's obligation to find out what the result would
be under the CS.
MS. DELBRIDGE responded, "The fiscal note will be something that
is forthcoming from the department. We have a general sense,
based on the reductions of overall support, that this would have
reductions to the outlay of state credits that would then
certainly affect the state's budget."
REPRESENTATIVE JOSEPHSON said he sees some things that are
interesting for him from his perspective, but that the state's
problem is now as well as 2022. He asked whether there is any
sense of what Version P would do to the budget.
MS. DELBRIDGE answered that HB 247 as presented by the
administration had immediate and retroactive effective dates.
The immediate effective dates would have occurred in July 2016,
which is the middle of the tax year. The direction from the co-
chairmen was that changes should be responsibly made to the
effect of providing companies ample time to adjust their
investment and spending for a tax year, and therefore provisions
should not take effect until the beginning of the new tax year
in January 2017. That would then have the impact of not having
immediate budgetary impacts for the state's budget this year.
1:31:59 PM
REPRESENTATIVE JOSEPHSON, regarding Version P, said he does not
understand the sequence of making very serious changes to the
Cook Inlet credit system and then later doing a [legislative]
working group.
MS. DELBRIDGE responded that the co-chairs heard clearly from
enalytica, the legislature's consultant, that the current Cook
Inlet direct state support is excessive and the state may not be
receiving benefit proportional to its direct investment through
the credit system. This is an attempt now to immediately curb
that direct state support while providing some level of
protection for current investments during the undertaking of a
wholesale regime evaluation. The reason the co-chairs wanted to
establish the [legislative] working group is that they heard
equally clearly from the consultants that a good regime that is
stable and predictable and lasts 10 years is the right thing to
do to maintain industry's investment and interest in Alaska and
the production that is needed. To establish the kind of regime
that is going to have lasting power of 10 or more years requires
time and great deliberation and a very serious deep inquiry.
Doing this over the interim with it coming back to the
legislature in 2017 provides a grace period to ensure that
everything is being examined top to bottom related to this
regime - gas supply, gas security, gas rates, oil, and the rest
of the world. The co-chairs were also hesitant to make
wholesale regime changes right now in a very challenging fiscal
environment under which industry is suffering greatly due to low
oil prices. The existing Cook Inlet regime sunsets in 2022 per
statute. Having a working group undertake this evaluation
sooner rather than later so as to have something under
evaluation by the legislature in 2017 allows time for this
working group to determine how to phase in or make effective
those changes that have the least damaging effects possible on
current investment and activity.
1:35:08 PM
REPRESENTATIVE TARR addressed the selection of credits that
Version P is choosing to use. She noted that the original bill
moved much more to the net operating loss framework while
Version P would keep several credits. She requested Ms.
Delbridge to talk further about why the preference of keeping
all three credits rather than consolidating into net operating
loss as a simpler way to address that.
MS. DELBRIDGE answered that the net operating loss concept as
kept in the original version of HB 247 would sort of mirror what
is in existence on the North Slope. However, on the North Slope
there is also a tax of substance and the net operating loss is
designed to be equivalent to that same production tax. In Cook
Inlet there is very little to no production tax, although the
state receives benefit via royalties and economic gains of jobs.
There are certainly companies that may not be in a loss position
necessarily in Cook Inlet should oil prices increase a little
bit, but that may still need to draw on a degree of state
support to continue building their business in Cook Inlet and
continue their investment. So, maintaining that level of a QCE
credit that supports that capital investment and continues work
underway seemed like a reasonable route forward to the co-
chairs. Once a Cook Inlet regime is established, understandably
there may be a tax and maybe a proportional loss provided as
well.
1:37:20 PM
REPRESENTATIVE JOSEPHSON, relative to the [legislative] working
group, asked whether the intent in Version P is that provisions
such as the January 1, 2017, stepdown of the WLE [credit], for
example, could be undone "if the facts would take us where they
lead us" and that the credit system as it exists may be made
fully whole if the case is made that it should be. He said he
is saying this in the context where in 2008 the state paid $53
million and this year it is $650 million, which he thinks is a
1,200 percent increase. He further asked whether that is
sustainable. Responding to Ms. Delbridge, he clarified that for
the term "fully whole" his is meaning that if this bill became
law, soon into the Thirtieth Alaska State Legislature this work
would be undone and the WLE be made 40 percent again.
MS. DELBRIDGE replied the co-chairs felt that while a whole
regime change is being undertaken it is appropriate to stepdown
the WLE [credit] in particular. The WLE [credit] is an extra
benefit for a segment of work that came about through the 2010
Cook Inlet Recovery Act. It was in a sense a fire-alarm-pull
emergency measure related to rolling brownouts and a fear of
serious gas supply shortages and the prospect of importing LNG
to Southcentral. It accomplished the desired effect and Cook
Inlet has pulled out of the situation somewhat with gas under
contract mostly for the next 10 years or so. The co-chairs were
equally clear that they do not intend to pull the rug from
underneath businesses that are doing work in exchange for that
benefit. Stepping it down was therefore a logical thing to do
through that interim period. Other than to present the plan to
the legislature in 2017 regular session, there are no
requirements in the working group's direction as to whether its
newly developed regime should not take effect until 2022 when
the current regime sunsets, whether it should take effect
immediately for some reason, or whether it should also phase in.
On the North Slope, Senate Bill 21 [passed in 2013, Twenty-
Eighth Alaska State Legislature] had a provision for sort of a
two-year interim period. Transitional investment credits were
also offered for the production profits tax (PPT) [passed in
2006, Twenty-Fourth Alaska State Legislature] to Alaska's Clear
and Equitable Share (ACES) [passed in 2007, Twenty-Fifth Alaska
State Legislature]. So, it is not uncommon to phase something
in or out. This starts to stepdown that support, acknowledges
that the WLE [credit] has worked to a large degree related to
energy security and was an amplified benefit for a special
reason that can start being stepped down.
1:40:59 PM
REPRESENTATIVE SEATON noted that Section 16 of Version P would
limit the repurchase of tax credits to $200 million [per company
per year], while the limit in the original bill was $25 million.
He questioned whether that number is at all effective, whether
it is any limit at all. For example, he pointed out, four or
more players on all of the major fields would bring the total to
$800 million per year.
MS. DELBRIDGE suggested this question be posed to enalytica, but
said the thinking of the co-chairs was that $200 million is a
generous limit and rather than being an immediate-year budgetary
protection it is intended to cap the state's potential liability
against an outlier development, a development that is on a much
greater scale than the work seen to date. Multiple companies
could certainly be participating, it would not be capped per
project. The $25 million cap was the starting point brought
forward by the Department of Revenue in the administration's
bill. She believed the number to be similar to the number in
the PPT era, adjusted for inflation maybe $40 million today;
Version P says $200 million. For as many partners as someone
brings in to a field, she continued, those partners would all be
needing to spend a great deal of money in order to receive up to
$200 million of a net operating loss, and each partner brought
in would further dilute the original company's reward. So,
while it is a possibility that eight players could be brought in
so that all eight players can get $200 million apiece, it might
be hard to truly identify a situation where a partner will feel
that it is in its interest to bring in that many partners that
then reduces its reward in the end.
REPRESENTATIVE SEATON pointed out that the current major fields
all have more than four partners. He said he would like the
committee to look at the aforementioned as it goes forward.
1:44:17 PM
REPRESENTATIVE SEATON noted that Section 27 would repeal the QCE
credit and inquired why qualified capital expenditures would be
redefined if they are no longer being used for credits.
MS. DELBRIDGE replied that the term "qualified capital
expenditure" is used in conjunction with other tax provisions
not related to the credit. For other tax purposes Alaska
statutes say that certain things must be a qualified capital
expenditure. Instead of defining it on its own, the bill says
that means what it means in the credit. So, if qualified
capital expenditure no longer exists defined in the credit, a
definition of what that is needs to be supplied elsewhere in
statute so that it can continue to apply to the other sections
of tax statute. Responding further to Representative Seaton,
she agreed to provide the committee with a listing of those
other places in statute.
1:45:29 PM
REPRESENTATIVE HERRON commented that Senate Bill 21 looked at
credit reform on the North Slope while [HB 247] looks to the
Cook Inlet. Neither the administration's bill nor Version P
address other credits that are expiring soon, he noted, and
those expiring credits are going to save the state money and
reduce cash-back credits. Regarding the proposed [legislative]
working group, he said the target audience is actually the
legislature because of the state's deficit and so the
legislature is who the target audience has to be. He agreed the
working group should be done during the coming interim. He
requested that Mr. Alper be able to provide an initial comment
on Version P later today.
1:47:10 PM
REPRESENTATIVE TARR addressed the "very generous" $200 million
limit and the possibility of it encouraging unwanted behavior.
She recalled that a criticism of the ACES regime was that the
capital credits were not linked directly to production and led
to spending that did not result in new oil production. In this
current low price environment, she continued, it has been said
that this system is still encouraging activity and she would
like to know why [the co-chair's] would feel comfortable saying
that this would not occur should prices reach $50-$60 and a
company has not yet reached a profit point.
MS. DELBRIDGE understood that Representative Tarr's concern is
about a situation of not a rock bottom price but not quite good
profitability yet, and what would prohibit someone from spending
a lot of money to hit that $200 million cap on production.
1:48:47 PM
REPRESENTATIVE TARR pointed out that [the cap] is not directly
linked to production, but to overall spending. She questioned
whether it is being ensured that it is not so generous that it
encourages spending that is not directly linked to production, a
criticism of ACES, and the state would then have a substantial
liability related to that. She asked whether this was thought
about when $200 million was recommended as the right number.
Responding to Ms. Delbridge, she confirmed that her question is
referring to what used to be called "the gold plating."
MS. DELBRIDGE responded by looking at what the $200 million cap
would actually apply to. It only applies to refunds per year.
A legacy producer with more than 50,000 barrels of production a
day does not get any refunds, so this producer can be taken off
the table. That leaves a small producer with a loss that can
get a refund or a newcomer without any existing production that
is developing something. A company's continued expenditure on a
development might not be directly related to the current price
of oil, but to the company's expectation of profit and
expectation of oil price farther out into the future. There did
not seem to be a real concern that there would be amplified gold
plating because this credit limit is quite high and, based on
what is seen in the Revenue Sources Book, most likely is not
necessarily something that is being reached anyway. To have
this situation occur it would have to be assumed that a company,
because there is now a limit that it has not reached yet anyway,
would be spending more. She urged that this question be posed
to enalytica.
1:51:20 PM
REPRESENTATIVE TARR, regarding North Slope [legacy producers],
noted that even though the state is not making a cash outlay, it
is essentially not getting money. She posited that this does
impact the overall budget picture because those are dollars that
would otherwise be paid as production tax. She surmised that
for the North Slope [the co-chairs] feel comfortable that [a cap
of $200 million] would not encourage gold plating.
MS. DELBRIDGE answered that that was not a concern because in
such an instance the company is at a loss position already, so
it seemed difficult to construe of a company interested in
driving itself deeper into a loss situation in order to get more
of a credit that is going to be applied against its future tax
liability. There are rules related to how a company can take
the 35 percent net operating loss deduction and for what.
Maintaining that status quo of a company's ability to calculate
that loss and to carry it forward was something that the co-
chairs wanted to maintain.
1:52:46 PM
REPRESENTATIVE JOSEPHSON on this same subject, recalled Director
Alper using Armstrong Oil & Gas Inc.'s Pikka unit as an example
of a 75,000 barrel model where in the out-years the people of
the state would benefit if it all came to fruition, but in the
near term the state would be out well over $1 billion. In this
case, he maintained, the state would own it metaphorically - the
state would become attached to this field and burdened by that.
While the state could tighten its belt and try getting through
those tough years to the golden egg at the end, it would be
tough to do. He expressed his concern that Armstrong might
delay its development slightly in order to benefit from $200
million a year.
MS. DELBRIDGE replied that generally speaking industry that is
invested far more than the state's contribution in development
is going to want to get production as soon as possible to start
realizing that benefit. The $200 million would certainly be a
cap against what is the state's exposure related to that kind of
a development. She said she believes there was not real concern
that a company might delay development to be able to continue
incurring a loss when it had production in sight that was going
to help start the returns on its own investment, which is
multiple times what the state's investment would have been, in
cashing out a loss.
1:55:00 PM
REPRESENTATIVE HERRON noted the governor's proposal [of a $25
million cap] was much less than $200 million. He asked why $200
was chosen and not $175 or $150.
MS. DELBRIDGE responded there was much discussion about this.
Ultimately the co-chairs' approach was not to set some arbitrary
limit that would potentially have impact on today's activities,
but simply to protect against an outlier, something that is so
much bigger than what is known as regular business today and
could be beyond the reach of the state to continue supporting.
The $200 million was not meant to curtail what anyone today is
able to receive in that refundability, but to protect against
outliers. The $200 million is a generous cap, but the approach
is from a resource development perspective as opposed to an
immediate deep cut related to the state's budget.
1:56:46 PM
REPRESENTATIVE TARR inquired whether the proposed legislative
working group is envisioned to be bi-partisan, given the
language does not designate seats for members of the minority.
MS. DELBRIDGE offered her belief that an assumption was made
that the two chairs of this working group would be very
responsible that way and be reflective of the legislature as a
body, which would account for respecting that there are majority
and minority members in the legislature. This was a fairly
broad starting point to provide the two co-chairs a lot of
discretion as to numbers and things like that. She imagined
that the co-chairs would entertain an amendment being more
explicit about the membership.
CO-CHAIR NAGEAK added that there was deliberation regarding
including as many people as possible.
1:58:01 PM
REPRESENTATIVE SEATON, regarding the legislative working group,
commented that there will be some select legislators who are
going to work on this when the legislature has committees that
have this as their responsibility. There are committees that
are already formed that have people who have been working on
this issue for months. There is the possibility of having
legislators who are just starting to get up to speed on this
issue and it seems like it might be a committee process that
might need to be there as well. He urged that at some point it
needs to be determined why the committee structure cannot work
on the problem in the way that is being proposed.
CO-CHAIR NAGEAK replied it is always nice to get other ideas
from people not related to this subject, but said the suggestion
will be taken under consideration.
1:59:11 PM
CO-CHAIR NAGEAK recognized Mr. Ken Alper.
KEN ALPER, Director, Tax Division, Department of Revenue (DOR),
explained he is here today to answer questions [on behalf of the
governor]. He said the Department of Revenue will be providing
a structured presentation on 3/21/16.
1:59:31 PM
REPRESENTATIVE HERRON understood that in developing the proposed
CS the co-chairs asked questions of Mr. Alper. He requested Mr.
Alper to provide an initial reaction to the proposed CS.
MR. ALPER clarified he is not before the committee as himself
but as a representative of the administration and to his
knowledge the governor has not seen the proposed committee
substitute. He explained that [DOR] needs to speak to its own
superiors before providing any formal reaction. He noted that
the administration's bill had four sets of things that the
administration was looking to change. One related to the North
Slope regime and certain limitations on repurchase, one related
to the Cook Inlet regime, one related to the minimum tax, and
then a number of miscellaneous provisions. Therefore, any
reaction he might have is going to be somewhat different in that
the elements of the bill have been capped or modified somewhat
differently related to the four different themes. Regarding the
North Slope side, he said he appreciates the co-chairs'
determination to maintain the core provisions of Senate Bill 21.
Senate Bill 21 was very much of a North Slope tax change and was
protected and defended through the referendum process, and there
was limited desire to make those changes. He further said he
appreciates the maintenance of the gross value reduction (GVR)
and net operating loss comingling issue that Mr. Mayer [of
enalytica] referred to as something of an unanticipated
circumstance and that will maintain value.
MR. ALPER said he has some concern with the use of a $200
million per company per year limit. Addressing Representative
Seaton's concern about the potential for this being multipliable
through multiple partners in the same project, he recalled that
[during the committee's 1:10 p.m. meeting on 3/7/16] he provided
a life cycle analysis of something comparable to what the
Armstrong project [Pikka Unit] would look like. This analysis
showed the state's credits peaking at about $800 million per
year. With a couple of partners that does not make that much of
a material difference in a $200 million limit. Yesterday, upon
receiving a preview of Version P from the co-chairs, he reviewed
historic records to see where that sort of limit had been
approached in the past and found one instance in a prior year
where a single company received more than $200 million in a
single tax credit refund. He therefore expressed his hope that
the committee might consider something of an in-between number.
2:02:32 PM
MR. ALPER, in regard to the Cook Inlet side, offered his
appreciation for the desire to phase things in. He said the
administration was looking for a much more immediate effective
date with two major changes. The administration was looking to
go from a level of 65 percent at max to 25 percent. [Version P]
would go to a 30 percent level and would provide about an 18-
month delay in getting to that 30 percent level, but that is not
a tremendous hurdle. In regard to members earlier questions
about what the difference is between offering a 25 percent
operating loss versus a 30 percent combo-credit that includes
the capital, he said the main difference has to do with who
would be benefitting from it. Specifically, the administration
was looking to reduce to zero any benefit through cash to
producers that were in production earning a profit not paying
taxes due to the tax cap but under current law were still
eligible to receive the well lease expenditure and capital
credits. [Under Version P], those sorts of entities would
continue to be able to earn credits at the 20 percent level even
if profitable and not paying taxes. In his opinion that is the
primary difference between the two different structures, the 5
percent difference between the 25 and 30 being less material.
MR. ALPER said the administration came before the committee with
changes to the minimum tax and given that those have been
eliminated wholesale from Version P there is really not a lot to
comment on. He added he does think there is a very substantial
difference between the conversation over going between 4 and 5
[percent], which did in many ways speak to core provisions of
Senate Bill 21, and certain hardening of the floor issues. If
he were to try to debate and pushback, he would personally be
pushing back on the hardening provisions, but he does not yet
have his direction from above.
MR. ALPER, regarding the miscellaneous provisions, offered his
belief that Version P does a very good job of preserving some of
the smaller less material issues that the administration raised
as technical issues that were discovered in current statute,
such as the municipal credit pro rata issue and the other
liability to the state issue. Stating his belief that compound
interest was an oversight in the last committee substitute of
Senate Bill 21 when it was in the House Finance Committee, he
offered his appreciation for the restoration of compound
interest, but said he personally believes the rate is still too
low. Alaska is entering a world where state government is going
to be operating on the earnings from the state's savings. There
is an opportunity cost to that, he pointed out, and an interest
rate tied more closely to opportunity cost is an appropriate
mechanism. He said he will provide more details on 3/21/16.
2:05:38 PM
REPRESENTATIVE JOSEPHSON understood it would be illegal for Mr.
Alper to tell the committee who the single company was that
received over $200 million [in a single tax credit refund].
MR. ALPER replied correct.
REPRESENTATIVE JOSEPHSON said his sense is that the $500 million
in savings might be reduced in the coming fiscal year to less
than $100 million. In that event, he surmised, the only
comprehensive fiscal plan that he has seen, the governor's plan,
does not balance and something would have to change about the
governor's change.
MR. ALPER responded that the comprehensive fiscal plan the
governor brought to the legislature had nine different bills as
well as certain expectations about the use of savings in the
future, and it did not get to balance until 2019. [Version P]
would certainly be a rollback from that balancing point and will
require other measures. Other caveats are that all nine bills
do not seem to be moving this year. Nothing that DOR will be
providing the legislature and the public a spring revenue
forecast update on 3/21/16, he said the other issue is that it
will be seen that the state has less money than was thought
because the price of oil is lower than was expected when the
update was done in December. There is going to be a number of
updates to the bottom line and how that might inform the
discussion for how to balance the budget in years to come.
Regarding the total fiscal impact of this bill, he said he does
not want to get into numbers prematurely because that is ongoing
work. The $500 million that DOR suggested as an initial impact
of HB 247 was an initial year number, it decreased in the years
going forward simply because of DOR's limited knowledge of what
the credit spend is going to be two, three, and four years from
now. The department does not know and cannot predict company
behavior, the department only knows what the companies tell it.
That baseline number itself is going to be changing due to the
forthcoming spring forecast update. Of the number that DOR
brought before the committee, about $100 [million] was on the
revenue side related to the minimum tax, and he can comfortably
tell the committee that the new number is zero. He confirmed
that the other $400 million, which is the savings from reduced
or deferred credit payment, is going to be a substantially
smaller number.
2:08:28 PM
REPRESENTATIVE TARR noted that Version P has no provisions about
confidentiality or sharing of information, and asked whether Mr.
Alper has an initial reaction to that. She said the committee
has heard that this might be difficult because the structure of
HB 247 relied more on the net operating loss credit and what
that might tell about the entire company profile. Given Version
P would maintain the QCE and WLE credits, she surmised it would
be easier, then, to get at that confidentiality.
MR. ALPER concurred that Version P removes the provision in the
governor's original bill that would have made public certain
information about which companies receive tax credits and how
much. He shared that DOR was concerned that in a world of
almost entirely net operating losses the reporting of the amount
of a net operating loss credit would effectively enable someone
to back-in to the size of a company's loss, which is currently a
taxpayer confidential number. Version P would have a broader
mix of credits remaining, possibly ameliorating that problem
somewhat. He suggested that Ms. Delbridge might have additional
insight into what the thinking might be in regard to future
potential language on the confidentiality issue. He pointed out
that Version P also removes the original bill's data sharing
provision relating to the Department of Natural Resources (DNR)
and the exploration and seismic data. He said his understanding
of why is because some of that authority remains in the existing
AS 43.55.023(a), which is no longer being repealed. However, he
qualified, he does not fully understand the details of that
since he has not yet spent that much time with Version P.
2:10:24 PM
MS. DELBRIDGE confirmed that the sharing of certain information
about companies that are receiving credits is not included in
Version P. She said there were concerns about whether requiring
a taxpayer to waive confidentiality that is essentially provided
by the federal and the state constitutions had broader
implications; it certainly concerned the taxpayers a great deal.
The co-chairs acknowledge that the net operating loss (NOL) is a
greater concern, as was stated by Mr. Alper. The NOL is still
there on the North Slope as the sole credit available. In that
instance there would always be those concerns related to
confidential information and what Mr. Alper described as the way
for someone to back-in to a company's proprietary information
related to disclosure of the NOL. In Cook Inlet the NOL remains
but is decreased, and the well lease expenditure [credit] would,
via a forthcoming amendment from the co-chairs, be gone in a few
years. The qualified capital expenditure [credit] would remain
and certainly that is one credit remaining to which someone may
want to look. In regard to the significant list of other
credits that will sunset in statute this year through inaction
to renew them rather than through this bill, she said those
certainly were very targeted and some very generous, and without
those in place there may be less of a need to understand
precisely what in a public forum.
2:12:13 PM
MS. DELBRIDGE noted that in regard to data sharing provisions,
the 30-40 percent alternative credit for exploration expires
this year for both the North Slope and Cook Inlet, but continues
until 2022 in the Middle Earth. Use of that significant credit
has resulted in data sharing for exploration and seismic work to
DNR. As Mr. Alper testified, the discontinuation of that credit
drove the desire to backfill some of that with data sharing via
other credits. This was discussed at length. The qualified
capital expenditure (QCE) credit and the well lease expenditure
(WLE) credit both have two parts to them. The first part is for
lease expenditure work and the second part is for exploration
and seismic. Explorers applying for those two credits would
still be incumbent to abide by the data sharing provisions in
statute in AS 43.55.025(f)(2), the data sharing provisions for
the alternative credit for exploration. Current statute
provides that for exploration and seismic work a company is
still subject to that data sharing, there would still be credit
incentives that through the statute "subs" directly relate to
exploration and seismic. If fewer people are doing this work
and getting credits for it because of the sunset of the big
credit, the alternative exploration credit, there might be a
reduction in that data. The Alaska Oil and Gas Conservation
Commission (AOGCC) receives data from companies for producing
wells and well developments on existing leases that is not
exploration and seismic. Most of the data is publically posted
on AOGCC's website within 30 or 60 days, she believed, and
extensive information is also available on AOGCC's website for
the non-explorer seismic. Because AOGCC does not have duties
and responsibilities related to seismic activity it does not get
the seismic data.
2:14:42 PM
REPRESENTATIVE HERRON agreed that Section 30 probably needs some
more detailing done to it. He inquired whether there should be
a review of repealing the Oil and Gas Competitiveness Review
Board that is currently in place.
MS. DELBRIDGE answered that the Oil and Gas Competitiveness
Review Board has multiple missions, one being the ongoing review
of the state's competitiveness on the North Slope regime. She
said it is certainly up to the committee to determine whether
the value of that is ongoing. This board was also specifically
tasked with considering the Cook Inlet regime. In looking at
this there was a desire to be more immediate and legislatively
focused as to a 2017 examination of the Cook Inlet regime.
Therefore the review board's task for Cook Inlet may be
accomplished through the [legislative] working group proposed in
Version P. The review board's big mission related to Alaska's
competitiveness with jurisdictions around the world for big
investment dollars on the North Slope is separate from that.
REPRESENTATIVE HERRON stated that in his questioning he forgot
that he wanted it to be narrower about leaving the duty to study
Cook Inlet and for the board to do the global review which he
knows is necessary. He asked Mr. Alper whether the review
board's task on the Cook Inlet should be suspended and to let
the legislature review it because the target audience is the
legislature given it is an important policy call.
MR. ALPER qualified he is speaking off the cuff, but that there
is a fundamental difference between the North Slope and the Cook
Inlet. The primary mission of the Cook Inlet has historically
been to provide energy for Alaskans, although there is certainly
an export component and an industrial component. [The mission]
of the North Slope is being Alaska's big revenue generator. So,
there are different missions in trying to attract investment.
The existing Oil and Gas Competitiveness Review Board is in many
ways kicked to the administration, it is staffed out of the
Department of Revenue and DOR works in researching and reporting
with legislative entities, whereas the [proposed legislative]
working group would very much be a legislative-led committee.
He said he does not know that there is necessarily a need for
two, maybe just a need for consensus over how to structure it
and what is the appropriate forum in which the analysis should
be done. He said he is more than happy to not take on a major
new task inside the Tax Division in an era of major budget cuts.
2:18:25 PM
REPRESENTATIVE JOSEPHSON, relative to the [proposed legislative]
working group, recalled that Senator Giessel had a working group
that met about six times, generally three hours per meeting.
The House Resources Standing Committee has met 20 times. The
committee also met in Nikiski around June 16 [2015] for several
hours, at which Mr. Alper and the commissioner testified as did
the legislature's consultant, enalytica. Senator Giessel
invited basically anyone from industry who wanted to appear and
they did. A large report was written. As someone who believes
in scholarship, he said he believes it is great to keep asking
questions and be searching. He inquired whether the proposed CS
was designed to transition the WLE [credit] slower because of a
belief that the working group was essential given this
background where there is now 900 pages of documents and scores
of hours of hearings.
MS. DELBRIDGE replied that to sunset the WLE [credit] slower
would essentially mean to withdraw it completely now. The
proposed CS would stepdown the WLE [credit] beginning in 2017,
reducing it from 40 percent to 30 percent, and the next year it
would be 20 percent. As mentioned, there was an oversight in
Version P, it would potentially be amended by the co-chairs to
repeal at that point. So, it is a slow stepdown over two years,
this year and next year. It is not tied to the working group's
activities. The stepdown was related to the concept that
companies are using this today in Cook Inlet to provide gas and
oil. [The co-chairs] would like to moderate the companies'
potential changes in investment behavior by stepping it down
over these two years rather than withdrawing it all at once. It
is correct that [Senator Giessel's] working group has spent a
great deal of time and work and the WLE [credit] stepdown is not
related to those timelines.
2:21:07 PM
REPRESENTATIVE SEATON noted that at about $700 million a year
the oil and gas tax credits is one of the largest expenditures
in the state's entire budget. He said he thinks $73 million is
allocated in the house and the senate budget for this. He
argued that the proposed CS would not make significant budgetary
progress for fiscal year 2017, because it does not start to make
any difference in Cook Inlet until halfway through fiscal year
2017 and there is no difference at all in the refundable tax
credits for the North Slope. He said he is having difficulty
with the slow ramp-down in Cook Inlet and the exclusion of any
effect at all on North Slope refundable tax credits as to where
the state will get those funds because those funds must be
generated from somewhere. He added that he is having a very
difficult time with taking $1,000 from every person's dividend
and then using it to go right back out to pay tax credits. Some
members will be thinking things are too much and some thinking
too little. Reducing refundable tax credits on the North Slope
cannot be ignored in any bill that the committee goes forward
with, because that is a huge budgetary expense. The talk is
about needing to do budgets and almost no budget cuts are seen
here. He urged that as the committee goes forward the
parameters be looked at for what needs to be done for the
state's budgetary situation and to move things a little quicker
and more holistically across both basins.
MS. DELBRIDGE answered that the direction from the co-chairs to
the staff who helped develop the CS was to be cognizant of the
state's budgetary situation. However, the co-chairs are not in
a position on this committee where they are hearing fiscal bills
as a whole picture and there is then a balancing act to look at.
In this committee the co-chairs wanted to focus somewhat on
responsible resource development policy. So, while aware of the
budgetary concerns, the potential impacts to industry of
immediate and dramatic changes in order to resolve a short-term
or immediate-term budget problem could have fairly significant
effects to the state's production in future years where, for
better or worse, the state is still looking to a single industry
for the majority of its revenue coming in. The co-chairs were
clear that there is this balance to be had at some point. If
the bill progresses from this committee it would go to the House
Finance Committee, which is hearing a number of fiscal related
bills and is perhaps in a position to truly assemble the pieces
in a manner in which the ultimate package has the impacts that
Representative Seaton is articulating.
2:25:44 PM
REPRESENTATIVE SEATON clarified he was not at all knocking staff
or saying that staff was not following direction, rather he is
talking about the committee's work in the direction of the CS.
He reiterated that some people will think it is too much and
some will think it is too little as the committee goes forward.
As a legislature, members are involved in a number of these
topics to figure out where to make cuts and where the revenues
are going to be, and this is one of the most significant places
to look for cuts. He understands staff is following direction,
he continued, but he is not sure the committee can afford to
ignore that direction. If these oil prices are maintained, he
is not sure the statement is correct that oil is going to be the
significant funder of the state; that may not be revenue the
state can rely on when deficits are three times more than
revenues. Therefore, he is drawing members to that as the
committee considers the bill going forward.
CO-CHAIR NAGEAK responded that that is what is being done and
the co-chairs are cognizant that the biggest funder of the state
is in dire straits also. Something must be done, a discussion
has been started, and the co-chairs are continuing on with the
conversation knowing that if nothing is done there will be even
more problems later. Everything must be discussed that drives
the state to come up with something that will be workable with
all concerned. It must be a deliberate process, everyone must
be heard from if the state is going to continue working with tax
credits and other things, and it must be ensured that everyone
understands why this is being done.
2:30:10 PM
REPRESENTATIVE TARR, regarding where the committee is headed
with Version P, recounted that a criticism of ACES was that it
made small producers winners over the "big three" on the North
Slope. Senate Bill 21 was supposed to correct some of that and
did not really deal with Cook Inlet. She said it appears that
Version P would create winners and losers in Cook Inlet and
would discourage any new entrants over this two-year period as
things are scaled back. The proposed stepping down is so that
companies currently doing work are not disadvantaged, but the
net effect could be that it disadvantages new entrants going
forward. This concerns her, she continued, because in the
committee's discussions about gas supply it was stated that 10
years of supply are under contract. However, it has been
stressed that exploration, development, and production all need
to be encouraged at all times to preclude a lag in the supply
chain. Those early stages of work must be ensured, particularly
if the market becomes less constrained due to reopening of the
Agrium plant or the ConocoPhillips [LNG export] facility.
MS. DELBRIDGE agreed that something like Agrium reopening or the
renewal of exports because prices changed would be a game
changer for people who have currently made big investments in
Cook Inlet, particularly those with gas having potentially a
difficult time finding a market for that gas. She recalled Mr.
Webb of Furie Operating Alaska, LLC, ("Furie") testifying that
as of a few weeks ago Furie had only one contract at that point
in time for its gas and that the revenue to Furie from that gas
is insufficient for Furie to meet its debt. Since then, she has
seen a contract from Furie at the Regulatory Commission of
Alaska (RCA), and while not for a huge volume, every bit helps.
The co-chairs' position is not to discourage new entrants; it is
to suggest that if it is felt that 65 percent support upfront in
cash by the state is too much, then it is a concern to bring new
entrants into Cook Inlet to produce gas that people producing
now cannot necessarily find a market for or to find oil for
which the state may get royalty income and jobs but no
production tax revenue from. To moderate that level of state
support now while examining the entire regime would be the
responsible action so that the state is not putting out terms
saying it wants to continue paying 65 percent state support to
newcomers when the state is suggesting that the gain resulted
from that is not what the state was perhaps targeting.
Certainly the co-chairs' intent is not to discourage new
investment, but simply to do it in a way that does not require
that high level of state upfront support and becomes attractive
to companies where the system looks sustainable, fair, and
balanced for long-term business decisions.
REPRESENTATIVE TARR said a timeline needs to be put out of when
these other credits are going to expire. Another of her
concerns, she explained, is that as a policy it is being said
that once a company is making a profit the state is going to let
the company have credits. The North Slope is a bit different.
In some ways it is a lack of consistency, she continued. It has
been heard repeatedly that the state is trying to create systems
that have some stability or durability to them. She surmised
that Ms. Delbridge is acknowledging not getting there today by
including a [legislative] working group in the proposed CS. To
the extent [the legislature] can get closer to that, she said
she feels strongly about how hard [legislators] should get to
work there because that dominates so much of their time and also
because [legislators] have other important matters to think
about relative to the entire budget.
2:35:48 PM
CO-CHAIR NAGEAK asked whether Representative Josephson maintains
his objection to adopting Version P as the working document.
REPRESENTATIVE JOSEPHSON maintained his objection to adopting
Version P as the working document.
2:36:05 PM
The committee took a brief at-ease.
2:36:28 PM
REPRESENTATIVE JOSEPHSON withdrew his objection to adopting the
proposed committee substitute (CS) for HB 247, Version 29-
GH2609\P, Shutts, 3/18/16, as the working document. He noted he
is withdrawing his objection in anticipation of further
discussion of amendments in the coming week. There being no
further objection, Version P was before the committee.
2:36:48 PM
The committee took an at-ease from 2:36 p.m. to 2:43 p.m.
2:43:54 PM
CO-CHAIR NAGEAK announced that enalytica, the legislature's
consultant, will provide a presentation on Version P of HB 247.
JANAK MAYER, Chairman & Chief Technologist, enalytica, as
consultant to the Legislative Budget and Audit Committee,
provided a PowerPoint presentation, "CS HB 247: Impact of
Proposals." Drawing attention to slide 2, "CS HB247 SUMMARY,"
he addressed the North Slope provisions included in Version P.
On the North Slope, he explained, Version P would keep intact
the overall architecture of Senate Bill 21, but two key changes
would be made. The first change would remove the impact of the
gross value reduction (GVR) in calculating the net operating
loss (NOL). This refers to the issue raised by Mr. Alper that
under current statute it is possible to effectively get more
than 35 percent NOL support for North Slope spending in certain
circumstances, in particular for a new development on the North
Slope because the gross value reduction was included in the way
the net operating loss was calculated. The provision in Version
P would end that possibility. The second change would provide a
per company cap of $200 million on refundability of credits.
This would not have a major impact on the amount of
refundability that occurs at the moment, but would protect
against potential larger development in the future.
MR. MAYER continued on slide 2, next discussing the Cook Inlet
provisions included in Version P. Three principle credits apply
in the Cook Inlet, he said: the 20 percent qualified capital
expenditure (QCE) credit; the 40 percent well lease expenditure
(WLE) credit; and the 25 percent net operating loss (NOL)
credit. Version P would maintain the 20 percent QCE credit. It
would reduce the WLE credit to 30 percent in 2017 and would
effectively phase it out after [2018] by making it the same
level as the qualified capital expenditure credit. As per Ms.
Delbridge's testimony, he understood that a future amendment
would sunset the WLE credit at that point since the well lease
expenditure is a strict subset of the work that is eligible for
the qualified capital expenditure. Version P would reduce the
net operating loss credit from 25 percent to 10 percent.
MR. MAYER continued on slide 2 and reviewed the three overall
general provisions included in Version P. He said the first
would provide for compound interest, as opposed to simple
interest, on delinquent taxes. The second would provide the
ability to withhold from refundable tax credits the existing
liabilities to the state that a company has from its oil and gas
production. The third provision would establish a [legislative]
working group to look at a [new] Cook Inlet tax regime and
present that to the 2017 regular [legislative] session.
2:48:08 PM
MR. MAYER turned to the chart on slide 3, "BIG DIFFERENCE
BETWEEN NORTH SLOPE AND COOK INLET," and looked at the credits
refunded by the state versus the total revenues brought into the
state under the current fiscal system. He said there is a very
big difference between the revenue that comes from the North
Slope in production taxes, and especially royalties at these
price environments, versus the low to nonexistent production tax
in Cook Inlet and small amount of royalty that comes from the
much higher production volumes in Cook Inlet. In general when
looking across the years there is a fairly even balance between
the amounts of credit refunds in those two places. But, for
fiscal year 2015, which the chart depicts, credit refunds are
higher in Cook Inlet than the North Slope - $[404] million in
Cook Inlet versus $224 million on the North Slope. "The
difference in those two situations," he continued, "is a key
reason for the difference in those two impacts of the two areas
in terms of what this bill does."
2:49:34 PM
MR. MAYER moved to slide 4, "GVR RAISES NOL CREDIT ABOVE 35% OF
ACTUAL LOSS," to discuss the North Slope changes and impacts.
One of the two key areas on the North Slope, he said, is the
question of the interaction of the gross value reduction and the
net operating loss. The aim of the gross value reduction is to
lower the effective tax rate on new production. It does that by
focusing on the gross revenue part of the equation rather than
the actual tax rate itself. Because Alaska's tax system does
not ring fence, does not distinguish on the project level
between different projects, it is very hard to take a new
development and say it should receive a lower tax rate.
However, those differences can be tracked at the level of
production out of revenue. The surprising and counter-intuitive
effect [of the gross value reduction is that it raises the
effective rate of the NOL credit]. Current statute describes
the NOL as the ability to deduct costs against production tax,
and that production tax level is calculated using the gross
value reduction. The effect is to cascade that gross value
reduction into the way the net operating loss credit is
calculated, which means that rather than 35 percent of an actual
operating loss it is possible in some circumstances for a
company to be reimbursed for 35 percent of a gross-value-
reduction-enhanced operating loss, one that exists as a function
of that allowance, not because it is an actual loss.
MR. MAYER provided an example of the aforementioned by bringing
attention to the two graphs on slide 4. He explained that the
left chart looks at the after-tax cash flow of a new development
at a price of $70 per barrel and the right chart looks at that
same development at a price of $40 per barrel. In both these
cases there is a small difference in the cash flows under the
current law of Senate Bill 21 versus Version P. The difference
in the two lines on the chart is the impact of addressing this
issue with the interaction of the gross value reduction and the
net operating loss. This is something that applies at a wide
range of prices, but is particularly exacerbated at low prices.
The issue here is that in the early years of a new development
by a new company with no existing tax liability, there is no
effect of the gross value reduction because the company has no
production and no revenue. The gross value reduction goes into
effect once production starts, once the company has revenue.
During the early years of production with ongoing drilling, a
company's costs are greater than the revenue the company
receives from production, making a net operating loss. However,
the effect of the gross value reduction is to further lower the
gross value of that production, the production tax value, and
all the rest, and when that flows on into the NOL it increases
the value of the NOL. So, the difference in the dotted lines
between what Version P would do rather than current law, is that
the NOL would remain in place but would be strictly 35 percent
support for government spending and is the same as any other
company. He added that this would be consistent with what he
thinks was the legislative aim of Senate Bill 21, which was to
say uniform 35 percent government support for all actors.
2:53:19 PM
REPRESENTATIVE SEATON, regarding the graph at the price of $40,
observed that the difference between the lines for Senate Bill
21 and Version P goes both above and below zero. He asked
whether zero is the point at which a net operating loss is
generated so that everything above zero is no effect at all.
MR. MAYER replied that things are counter-intuitive here because
a few pieces affect this picture. One is how state, federal,
and corporate income tax are treated; these are applied "further
down the stack" after calculation of production tax and the net
operating loss there. Most of enalytica's modeling assumed that
a company with a new development still had other broader federal
tax liability and that therefore losses a company makes could
possibly be of benefit to the rest of its operations, and so
from an overall company perspective that it is possible
essentially to receive negative federal income tax. Thus, there
may be times when from a production tax value perspective a
company is at a net operating loss but may be very slightly cash
flow positive after considering the impacts of federal income
tax on the overall operations. So, zero is not a strict line in
terms of the way things on this graph are represented at which
an NOL is no longer payable, but it is very close to that and is
something slightly above zero at which a company no longer
becomes NOL eligible. Exactly how far depends on the direction
of numerous different bases of the system.
REPRESENTATIVE SEATON understood the graphs represent after-tax
cash flow for a new development and are from the company's
perspective, not the state's perspective for losses of revenues.
The graphs are from the company's perspective as far as the
company's cash flow instead of this interaction with the net
operating loss and the gross value reduction.
MR. MAYER responded correct, although the difference between
these two things is attributed to one thing only - the treatment
of the gross value reduction. The point of slide 4 is to say
that the impact of this is much greater at low prices than at
higher prices. The new development depicted in these graphs is
of the sort that enalytica modeled and previously presented to
the committee, which is $1-$1.5 billion in capital spending and
peak production around 20,000 barrels a year. At a price of
$40, the impact of this difference is less than $10 million a
year for most years and is limited to those years of ongoing
drilling in the early years of production. That difference
across the time period is sort of between $0 and $10 million a
year, and in most cases between $0 and $5 million a year. In
the graph for $40, the difference between those two lines is the
additional revenue to the state that would come from a project
such as this.
2:57:35 PM
REPRESENTATIVE TARR commented that due to the X axis being in
increments of $50 million it is hard to determine the difference
between the two lines. She understood Mr. Mayer to be saying
that generally that is about $5 million.
MR. MAYER answered that broadly speaking it is between $0 and $6
million for this particular model at these prices. He directed
attention to the fifth line of text on the slide that states an
impact of less than $10 million a year.
2:58:19 PM
MR. MAYER resumed his presentation. He addressed slide 5,
"REFUNDABILITY LIMIT FOCUSED ON FUTURE LIABILITIES," regarding
the second of the two key areas on the North Slope. He said the
key aim of the refundable net operating loss is to provide the
same benefit to new developers that existing producers have in
the way they are impacted by the tax system. What this means in
the vast majority of circumstances is that the impacts of a new
development on the producer, as well as the state, are the same
as if that new development had been done by an incumbent
producer. For example, if the hypothetical project modeled by
enalytica of $1-$1.5 billion in capital costs, 800 million
barrels in recovered resources, and 20,000 barrels a day at peak
production was undertaken by an incumbent producer, all of those
costs would be deducted against the producer's liabilities and
would reduce the producer's taxes paid to the state by that
amount. If a completely new company developed that hypothetical
project, the state would instead pay the company the refundable
net operating loss credit. In the vast majority of potential
price circumstances those two things are completely equivalent
to the state. The cash payment to the small producer is exactly
the same as the reduction in taxes for the larger producer.
Elaborating, Mr. Mayer noted that the big impact of
refundability [on the North Slope], particularly in a low price
environment when the budget is strained, is a timing issue much
more than an absolute spending issue. For instance, the
original version of HB 247 provided a very tight cap on how much
could be refunded. But a bill could provide that the net
operating loss is not refundable at all. If, over the course of
the entire project life, prices were sufficient to enable that
credit to be recovered from project revenues further down the
line, the total cost to the state (not considering the time
value of money) for an upfront refund versus a deferred credit
taken against future taxes is identical in the vast majority of
price cases. In that sense, this is a question of timing and
when those costs occur, and the fact that for a new development
they occur now versus a number of years into the future. This
has a big impact essentially on who can make development on the
North Slope work.
3:01:36 PM
MR. MAYER illustrated the aforementioned by bringing attention
to the left chart on slide 5 depicting cumulative cash flow of
this hypothetical new development with and without refundable
credits [on the North Slope at a price of $70 per barrel]. A
company developing this project under the current system of a 35
percent refunded net operating loss credit might need about $300
million in total capital to enable the project to occur. But,
if the NOL is non-refundable, a company might need $500 million
or more to make the project occur. Because this is all about
the timing of cash flows, not the total value across the project
life, the fact that for a new developer these come early rather
than later at the tail of the project means that, although the
total cash flows are identical, the internal rate of return
(IRR) is much higher under the current refundable scenario than
under a non-refundable scenario.
MR. MAYER stressed that those cash flows coming early lead to
substantial impacts. Making the NOL non-refundable or lowering
the limit to $25 million per company, and making it effective
immediately or very soon, would have a major impact on projects
that are presently being developed. There are two possible
solutions to that, he advised: one would be to take stricter
action but find ways to grandfather in existing developments;
the other would be to do something that does not place such a
tight limit on refundability. Tight limits on refundability,
whether that is a low per company cap or no refundability at
all, have a big impact on what sort of companies can undertake
investments on the North Slope. In particular, smaller less
well capitalized companies and companies that rely on private
equity participation for a substantial part of their investment
structure, require solid rates of return. Some of those
companies are currently able to make projects work on the North
Slope, but would be much less likely to be able to do so without
the refundable credits.
3:04:18 PM
MR. MAYER noted that the approach in Version P of $200 million
is a very high limit relative to the $25 million proposed in the
original bill. This would effectively avoid impacts on current
investment while, in principle, offering some protection against
future outlier projects. There is an important discussion to be
had as to what exactly that limit is and should be and what sort
of project there is concern about in the future, he said. There
was discussion earlier in committee about a hypothetical new
development roughly the magnitude of another Kuparuk, which to
date has recovered more than 2.5 billion barrels. A
hypothetical new development of 2 billion barrels that required
as low as $12 per barrel of reserves to develop would be a $24
billion development. If one-fourth of that spending was on
facilities capital expenditures that would be spent before major
drilling started and before this field began production, then
that would be $6 billion in pure net operating loss refunds.
Thirty-five percent of that $6 billion would be $2.1 billion in
total credits, which is a big number and one to be concerned
about in terms of potential future impact. That would not all
be in one year. For example, spread across three years it would
be $700 million a year, which is about the same number the Tax
Division talked about when it foresaw $800 million as a possible
future risk, and in which case the question is, How many
companies is that split between and what is the optimal level of
a limit that seeks to minimize its impacts on current projects
but constrains some of the state's potential liability in that
scenario? That is an important discussion to have, he
reiterated.
3:06:45 PM
REPRESENTATIVE SEATON asked whether the purpose of the net
operating loss is to deform the market so that companies do not
have to take other partners and can proceed without needing
other capitalization, but that the limit would be the exact
opposite which would force companies to take other partners so
that they could get the $200 million limit in multiple partners.
He further asked whether these two objectives are a kind of
juxtaposition.
MR. MAYER replied he would not say that the net operating loss
credit and its refundability distorts the market. In principle
it exists to make the economics of a new development, the impact
of the tax system and the actual tax that is received by the
state, the same for a new developer without a liability as it is
for a larger developer with a liability. The alternative of
protecting the state by not offering the NOL in a refundable
form is to say that the state understands that the economics are
substantially more difficult for projects to be developed by new
companies than by incumbent ones. That the economics naturally
look much better for incumbent companies than for new ones and
that the support, the cash that is provided through the tax
system, is effectively higher for incumbent companies than it is
for new ones. That is certainly a policy call that can be made,
he said, and he does not think there is an absolute right or
wrong on that. The purpose of refundability is not to distort
the system as much as it is to make the impact as even as
possible. It certainly mean that projects by smaller companies
are possible that might not be otherwise. An important question
to consider if this were to be changed is, What would be the
impacts in terms of the resource base on the North Slope to be
developed? Who might come in? Would things that are currently
being developed or might potentially be developed still be
developed in those scenarios? Regarding the possibility that a
limit of $200 million could encourage splitting up a major
project between more companies, Mr. Mayer said that when the
really low limit [of $25 million] was being discussed, he was
less concerned about this because it would be really hard to
bring in enough companies to make that work. But, at a limit of
$200 million, he can certainly see a case where a development
that might otherwise be undertaken by two or three companies
could end up being done by, say, four or five. It is a valid
question to raise, he advised. A further look in statute could
be taken as to whether there are ways to protect against that or
whether the amount of the limit needs to be considered further.
3:10:43 PM
REPRESENTATIVE TARR addressed the right chart on slide 5 showing
the internal rate of return (IRR) sensitivity under the current
law of GVR with refundable NOL versus a nonrefundable NOL. She
interpreted the graph as showing that to achieve a 15 percent
IRR would push it out from [a price of $70 under current law to
a price of] $80 under Version P.
MR. MAYER responded no, this would be if a stricter approach was
taken on refundability. So, if there are no companies with
existing development that are meeting that $200 million limit at
this moment, "then you're still on the solid black line of the
refundable net operating loss world." The purpose of these two
[graphs] is to say if one took a stricter approach, whatever
that stricter approach is, whether that was completely
nonrefundable or some type of cap, one is starting to push out
along those lines.
3:11:54 PM
MR. MAYER returned his presentation. Showing slide 6, "COMPOUND
INTEREST AND CREDIT WITHHOLDING," he explained that the bill's
key feature of moving to compound interest rather than simple
interest would increase the penalty for delinquent taxes. At
the current effective interest rate of 4 percent and the current
six-year statute of limitations, that impact would be pretty
small, a couple of million dollars. However, it would be a very
big difference under a timeframe of multiple decades. He said
he agrees with Mr. Alper that going from compound to simple
interest was an oversight in the drafting of Senate Bill 21;
compound interest is almost standard and makes much more sense.
Mr. Mayer said another key feature of the bill relates to
concerns around refunding credits to taxpayers that have
existing liabilities related to oil and gas production, for
example on royalties. It would not be that no refundable credit
would be given, but rather that that liability would be withheld
from any certificate issued and the taxpayer presumably would
have the option to then say that that withholding is the way in
which that liability will be discharged.
REPRESENTATIVE JOSEPHSON questioned what would actually change
here if in the state's view there is a delinquency or a contest.
He argued that a taxpayer would not agree to the discharge
because in not paying it the taxpayer is clearly contesting it.
He surmised that the advantage to the state is that this is
essentially a sort of escrow system where monies are subtracted
and held in abeyance pending resolution of the contest.
MR. MAYER agreed the aforementioned seems like a reasonable way
to characterize it.
3:14:44 PM
MR. MAYER continued his presentation. Addressing slide 7,
"REDUCTION IN COOK INLET SPENDING SUPPORT," he said the biggest
impact of Version P is in terms of the level of overall support
for spending in Cook Inlet. He reminded members that support on
the North Slope primarily means how much can be deducted against
an existing tax rate. However, he continued, support in Cook
Inlet is much more about credits that are a form of subsidy
provided to incentivize investment against a number of aims, in
particular security of supply of gas to Anchorage, not effective
investment that will be recouped through the tax system. Cook
Inlet [currently] has three credits: the 25 percent net
operating loss (NOL) credit that is then stackable with either a
20 percent qualified capital expenditure (QCE) credit or a 40
percent well lease expenditure (WLE) credit that is applied to a
subset of capital expenditures specifically related to drilling
wells. That means a company receives either 45 or 55 percent
support, depending on how much of its spending qualifies at a 20
percent level capital credit and how much of its spending
qualifies at the 40 percent well lease expenditure level. If an
even split is assumed, then on average, total support is about
55 percent under the status quo assuming that the company is
eligible for all of these things including the net operating
loss. For an incumbent producer not eligible for net operating
loss, support is about 20, 30, or 40 percent depending on how
much of the producer's spending is QCE-eligible versus WLE-
eligible. Version P would change this to 10 percent net
operating loss credit for the carried-forward annual losses,
stackable with effectively just a 20 percent QCE credit. The
intervening year of 2017 would have a 30 percent WLE credit and
after that the only credit remaining other than the 10 percent
NOL is a 20 percent qualified capital expenditure credit.
3:17:35 PM
REPRESENTATIVE JOSEPHSON recalled that there was testimony
limited to the question of the WLE [credit] being redundant in
terms of what it covers or subsumed into the QCE [credit]. He
expressed his concern about the effective phase out, noting that
[Version P] does not technically phase it out in language, but
says it becomes 20 percent in 2018. Given he is not an expert
in what a WLE is and has only been told that it has something to
do with deep water in the middle of the inlet, he inquired how
he is to know the WLE [credit] is going to be phased out because
it covers the same thing as the QCE [credit].
MR. MAYER answered he understands an amendment will be offered
that would sunset the WLE credit after 2018 or in 2018. The
reason is because expenses that are eligible for the WLE
[credit] are a strict subset of those that are eligible for the
QCE [credit]. To be eligible for the QCE [credit] an
expenditure has to be a qualified capital expenditure and there
are definitions under the tax code as to what that is. To be
eligible for the WLE [credit] it must be both a qualified
capital expenditure and meet some other definition of intangible
drilling costs under the Internal Revenue Service tax code. By
definition one is a subset of the other.
MR. ALPER suggested that Representative Josephson may be
confusing this with the so-called jack-up rig credit, the
deepwater Cook Inlet credit. He explained that the well lease
expenditure is a broad credit for all well related expenditures.
The term of art used in statutes is "intangible drilling costs."
The key point is that to qualify for the 40 percent WLE [credit]
a qualified capital expenditure must otherwise qualify for it
plus meet these additional criteria. The intent of Version P is
to step-down the WLE [credit]. Ms. Delbridge was trying to say
that at the moment where it hits that 20 percent level,
effectively there is no difference; to be a WLE it must already
be a QCE, so whether it is kept in statute or repealed becomes
immaterial at that point.
REPRESENTATIVE JOSEPHSON asked whether Mr. Alper agrees with Ms.
Delbridge.
MR. ALPER responded, "Ms. Delbridge and I have discussed and we
agree that to be a WLE ... it is a subset and must also qualify
for a QCE; so if the intent is to maintain 20 percent support it
shouldn't matter whether or not we repeal and it would be
cleaner for statutory purposes to simply repeal the WLE at the
point when it hits 20 percent."
3:21:13 PM
REPRESENTATIVE SEATON surmised that if the well lease
expenditure is a subset of the qualified capital expenditure,
then when the 40 percent well lease expenditure [credit] is
eliminated at the start of the fiscal year, all of the projects
would still qualify at that point in time for 45 percent tax
credit because they would have the 20 percent qualified capital
expenditure [credit] plus the 25 percent net operating loss
[credit], which are stackable. He inquired whether he is
correct in his understanding.
MR. MAYER asked whether Representative Seaton's question is
meaning if one maintained the NOL [credit] at its current level.
REPRESENTATIVE SEATON replied yes, if at the start of the July 1
date the NOL [credit] was maintained at 25 percent and would be
stackable with the qualified capital expenditure [credit], then
that would be 45 percent state support for the project at that
point in time.
MR. MAYER responded that if there were no WLE [credit], then,
yes, that is correct.
3:23:01 PM
REPRESENTATIVE SEATON restated his question for Ms. Delbridge to
answer. He posed a scenario in which the 40 percent well lease
expenditure [credit] goes away because it is a subset of the
qualified capital expenditure [credit], and there is still a 25
percent net operating loss [credit] and a 20 percent QCE
[credit] on July 1, the start of the state's fiscal year. He
asked whether the state would still at that point be providing
45 percent support for a project.
MS. DELBRIDGE replied she realizes the state's fiscal year
starts in July, but explained that Version P would not have
things effective until January 1, 2017, to coincide with the new
tax year. If in fact the WLE [credit] is not in place, and a 25
percent NOL [credit] is retained and a 20 percent QCE [credit]
is retained, then under her understanding a taxpayer could have
up to 45 percent state support if that taxpayer actually is
eligible for a loss. It would be a company-specific situation.
REPRESENTATIVE SEATON understood, then, that if a company was
making money and did not have a net operating loss, it would at
that point in time qualify for a 20 percent qualified capital
expenditure [credit].
MS. DELBRIDGE responded that if a company is not eligible for
the NOL then it would have the ability to use the 20 percent QCE
[credit] for certain lease expenditures. Rephrasing her
statement, she said there are ways that a company "might be able
to be making money and still have a loss in the sense of making
money is one thing and having production tax ..."
REPRESENTATIVE SEATON restated his question by noting that if a
company has a net operating loss it is not making money. "You
could be making money and ..."
MS. DELBRIDGE answered that if a company is eligible for a net
operating loss, it has losses.
3:26:05 PM
MR. MAYER resumed his presentation and summarized slide 7,
"REDUCTION IN COOK INLET SPENDING SUPPORT." He explained that
for new developments the producer would be eligible for a net
operating loss [credit], particularly in the early years of
capital spending when there is not yet production or spending is
greater than the production revenue that is occurring. Under
Version P, support for new developments in most circumstances
would be 30 percent - 20 percent qualified capital expenditure
[credit] plus 10 percent net operating loss [credit]. That
compares to 55 percent in those circumstances under the status
quo or 25 percent in the original bill. Under Version P,
support for current production which in almost all circumstances
is not eligible for a net operating loss credit, would be 20
percent. That compares to the status quo of somewhere between
20 and 40 percent, say 30 percent on average, or 0 percent in
the original bill because the original bill would provide
ongoing support only through the 25 percent net operating loss
[credit] versus the qualified capital credit. Elaborating, Mr.
Mayer said the approach taken by the original bill was that any
ongoing amount that is spent should only be effectively on new
developments by new taxpayers. The approach taken by Version P
is that this should be broad-based, that there should be 20-30
percent support for all companies undertaking this sort of work
regardless of whether they are eligible for the net operating
loss [credit]. So, it is not that new developments are
disadvantaged in Version P, they would receive 30 percent
support for spending versus 25 percent in the original bill.
Version P would also provide spending support for those not
eligible for a net operating loss credit, which was not the case
in the original version of HB 247.
3:28:42 PM
REPRESENTATIVE SEATON surmised that enalytica's recommendation
or analysis here, even in these times of the state not having
the money and having to raise other taxes to do it, is that
state support should be given on an equity basis between ongoing
production that is making money and new operations that are
having a net operating loss; not because it is necessarily
needed, but because it is an equity kind of situation.
MR. MAYER replied that this is not something enalytica is making
a recommendation on, but simply enalytica's analysis of what the
original bill did and what Version P would do. He said
enalytica's previously presented analysis looked at three types
of projects in Cook Inlet, as do [slides 8-13] in today's
presentation. One type is completely new developments that are
being developed to produce and sell gas into a highly
constrained market that is currently well matched in supply
capacity and that is only going to change slowly over time.
Projects in a highly constrained market have difficult economics
in almost all circumstances; credits make that slightly better,
but they are still much challenged projects. Another type is
unconstrained demand for such a new project, either because a
major new use of gas is found, such as export, or because some
other major customer comes into existence. In this instance the
economics of a new development look pretty workable in most
circumstances. If there is a need for support it is much less
in this type of environment and high prices can probably go much
of the way to making those projects work. The third type of
project is ongoing infill drilling and other capital work in
existing mature fields and enalytica's analysis is that this is
pretty solidly economic in most imaginable circumstances.
MR. MAYER continued his answer, advising that the next question
is really a policy call. Given the importance of gas security
to Southcentral Alaska, given the state's limited financial
resources, and given the desire to write a new regime, he said
the question is how quickly to withdraw support, whether that
should be done across the board, and whether to target
specifically for new development. Clearly, there is a strong
argument to be made that completely new development will
ultimately be what is needed to bring online the next tranche of
supply that is most difficult to develop at the moment but will
be most essential in five or ten years' time. That is a
difficult policy call to make. One could have the alternative
view that presently most of the supply is being met from ongoing
investment in the mature fields, but be concerned about whether
that will continue to the extent it has in the past if support
is cut off too quickly. That work is solidly economic in most
imaginable circumstances, according to enalytica's high level
economic analysis. However, Mr. Mayer cautioned, he cannot tell
the committee that therefore it will continue on an ongoing
basis if there is much less support, particularly if that
support is withdrawn immediately. Also, there is no certainty
as to what the ongoing fiscal terms are, at least for another
year. The sponsors of the committee substitute have taken a
cautious approach here, but this is all about a judgement call
as to what one thinks the right balance is.
3:33:34 PM
REPRESENTATIVE SEATON asked whether his understanding is correct
that the balance, or maintaining qualified investment credits as
a larger portion of this mix, would enable credits to flow to
profitable companies, whereas if it was more net operating loss,
then profitable companies would not receive the credits.
MR. MAYER responded that broadly speaking this characterization
is correct. If support is channeled solely through the net
operating loss credit, then only companies that make a net
operating loss would be eligible to receive that support. If
support is channeled through the qualified capital expenditure
credit, then all companies that spend, regardless of whether
they have substantial production and profits, would receive it
and that is spent more broadly on a wider range of activities.
3:34:43 PM
REPRESENTATIVE TARR, in regard to avoiding the picking of
winners and losers between new entrants and producers, asked why
not have a 25 percent NOL [credit] and a phase out of the WLE
[credit], but have the QCE [credit] be 25 percent. She posited
that this would make the opportunity match up better for the
company not in production as well as the company that is.
MR. MAYER answered that there are difficult trade-offs to make
and many good arguments for numerous possible structures. He
said he does not see this as picking winners. The proposed
level of support for new developments is higher in Version P (30
percent) than in the original version of HB 247 (25 percent).
The original bill's approach of solely channeling support
through the net operating loss credit was very much about
picking winners and losers because only companies making a net
operating loss would receive support, although this approach may
have some merit. The effect in Version P is to make this be
broader based, to less pick winners, because the overall support
is more similar between companies that make a loss because they
are developing new projects versus companies not making a loss
because they have substantial existing production.
3:37:0 5 PM
MR. MAYER recommenced his presentation, noting that slides 8-13
are updates of the modeling work for the three types of projects
that enalytica previously presented to the committee. He said
slide 8, "COOK INLET #1: MARKET CONSTRAINED (ASSUMPTIONS),"
models a new development in a constrained market. [Because of
the limited ability to sell gas], a well can only be drilled
every few years. Referring to the left chart, he said that in
this model the developer drills four wells, two in the early
years and then another two to maintain the plateau. Production
in the early years is 15 million cubic feet per day (Mmcf/d),
rising to 40 Mmcf/d in the later years. This is really
difficult economics to make work, he said. Referring to the
cash flow chart on the right, he noted that the [purple] bars
represent the spending of about $400 million in total capital
expenditure for a big facility to produce the gas. However,
because only a few wells can be drilled, this large initial
capital spending is only very marginally recovered even at a gas
price of $6 per thousand cubic feet (Mcf). Even though the
economics of this are pretty marginal, a net operating loss only
occurs for those first three years. What this means in net
operating loss credits versus capital credits is that for a new
project being done by a completely new developer, the developer
would be eligible in those first three years for the net
operating loss credit, whether that is 25 percent or 10 percent.
In the subsequent years, additional spending is primarily on the
drilling of wells when the company is no longer eligible for a
net operating loss [credit]. If the only support that is given
is through the net operating loss [credit], then that additional
work does not receive any support. If the support is through
the qualified capital credit, that work would continue to
receive 20 percent support. Under the original bill, a project
like this would receive 25 percent through the net operating
loss [credit] just for those first three years. Under Version
P, a project like this would receive 30 percent for all of this
work rather than just the first three years.
MR. MAYER turned to the six graphs on slide 9, "COOK INLET #1:
MARKET CONSTRAINED (RESULTS)." He pointed out that under the
status quo the level of government take is low with a negative
value to the State of Alaska, yet still a very strained project
in terms of ability to generate value for the company. Under
the original HB 247 with just a 25 percent NOL [credit], this
project would become much more strained; only at very high
prices of $8.59/Mcf or more does this project become net present
value (NPV) positive in terms of internal rate of return. Under
Version P, this project would be slightly better due to
(indisc.) and the fact that it would be 30 percent for all of
the spending, not just the first three years in development.
3:41:03 PM
REPRESENTATIVE SEATON referred to the top row of charts showing
the net present value split for the status quo, the original
version of HB 247, and Version P of HB 247. He observed that
the state would have a net operating loss at prices up to $7/Mcf
under HB 247 and up to $9.50/Mcf under Version P. He inquired
whether he is correct in concluding that at the current gas
price of $8.19/Mcf which goes through the year 2023, there would
be a net operating loss to the state for any project development
in a constrained market.
MR. MAYER clarified that these charts are about the net present
value to each of the parties. It is not talking about net
operating losses, but rather whether the overall value received
in discounted terms is positive or negative. He confirmed that
Representative Seaton is correct. Under the status quo, the
credits that are spent on a project like this are pure subsidy
and are a net cash flow loss in terms of the value of that cash
over time to the state. The credits are provided as a subsidy
for other purposes, not as a means of recouping revenue in the
future. Under both the original bill and Version P, that is
moderated to some extent insofar as there are prices under which
it could eventually be present value positive for the state.
Because the credits are slightly higher in the CS than in the
original bill, the price at which that occurs is substantially
higher under the CS than under the original bill.
3:43:20 PM
MR. MAYER resumed his presentation. Moving to slide 10, "COOK
INLET #2: UN-CONSTRAINED (ASSUMPTIONS)," he explained that this
model is for the same project, but in a hypothetical un-
constrained world. If there were the ability to sell gas to an
additional customer, then this project with the same upfront
facilities investment could go ahead with full field development
and produce an optimal amount of gas, in this case a plateau of
around 140 or 130 Mmcf/d. Drawing attention to the six charts
on slide 11, "COOK INLET #2: UN-CONSTRAINED (RESULTS)," he
continued his discussion of this project. Under the status quo,
he noted, this project would be a net present value positive
investment for a company. The rate of return would be solid,
especially with all the currently existing support for spending.
[Under the provisions of the original version of HB 247], most
of that support would be withdrawn and would be limited only to
the 25 percent net operating loss [credit], which would occur
only in those first three years or so of development. In this
case the project would be less highly valuable but would still
look like an investment that could work across a fairly broad
range of prices in that environment. Under the provisions of
the CS, Version P, things would be similar. The economics look
very marginally better for the company and very marginally worse
for the state. It is all differences at the margin and that is
because the core difference between Version P and the original
bill is 30 percent support rather 25 and support throughout all
of the years of ongoing drilling as opposed to support only
during the first three years of new project development for a
company that does not already have production.
3:45:40 PM
MR. MAYER reviewed slide 12, "COOK INLET #3: DRILLING EXISTING
FIELD (ASSUMPTIONS)," explaining that this type of project is an
existing mature field where there is already infrastructure so
no money needs to be spent for starting capital. Expenditure is
limited to the cost of drilling and higher operating costs.
Moving to slide 13, "COOK INLET #3: DRILLING EXISTING FIELD
(RESULTS)," he continued his review of an existing field. He
said this type of project would be solidly economic in a wide
range of gas price environments, with double digit internal
rates of return. The original version of HB 247 would provide
no credits for this type of project because in almost any
circumstance drilling in an existing field would not be making a
net operating loss, but according to enalytica's analysis it
would still be solid economic work to undertake. Under the CS,
Version P, there would be a 20 percent capital credit [and again
would be economic to undertake].
3:47:41 PM
REPRESENTATIVE JOSEPHSON compared slide 9, constrained market,
to slide 13, drilling existing field, and understood that a
constrained market is the world of Cook Inlet today.
MR. MAYER replied correct.
REPRESENTATIVE JOSEPHSON surmised that at today's prices and
lower, the companies that are producing would enjoy a [net
operating loss (NOL) credit].
MR. MAYER responded that slide 9 is not about any given year for
eligibility of an NOL. The charts on slide 9, particularly the
top row of charts, are about total value to the company, federal
government, and state government over the entire lifespan of the
project. In regard to the eligibility for an NOL, he brought
attention to the right chart on slide 8 for the cash flow at a
price of $6/Mcf and noted that a company is definitely eligible
for an NOL for those first three years in which it has strongly
negative cash flow from having spent $400 million on building a
facility. After that point the company probably does not have
negative cash flow and may well not be eligible for a net
operating loss at any point after that point in time. That does
not change the fact that under the status quo at $6/Mcf, this is
still a value destroying project if the cash flow is discounted
at a 10 percent rate of return.
3:50:15 PM
REPRESENTATIVE JOSEPHSON directed attention to the top middle
graph on slide 9 and observed that [for a new project in a
constrained market under the original version of HB 247], the
company would enjoy an NOL of 20 percent. In the top middle
graph on slide 13 [for drilling in an existing field under the
original version of HB 247], there would be no credits because
the project would be in the black. He requested Mr. Mayer to
explain further.
MR. MAYER pointed out that slides 9, 11, and 13 are presenting
the same series of charts for three different scenarios of
development. The left column on all three slides is the status
quo, the middle column is the original version of HB 247, and
the right column is the CS for HB 247, Version P. Slide 9
depicts the development of a completely new project in a market
constrained environment. In that circumstance a developer would
have a net operating loss credit in the first three years and
under the original bill that is the only credit the developer
would have. Slide 13 depicts drilling in an existing field,
which means drilling wells but never having to spend $400
million of capital up front to build an entirely new platform,
pipelines, and all the rest. They have very different economics
because they are very different projects. The middle column
depicts the projects under the original version of HB 247. This
column on slide 13 says no credits because this is a company
that would under most circumstances have substantial existing
production and substantial existing profits, and would never be
eligible for the NOL credits. This column on slide 9 includes
the NOL credits because it is a new development and that new
development would be eligible for the net operating loss credits
in those first three years of spending on all those facilities.
3:53:09 PM
REPRESENTATIVE TARR addressed slide 8 and noted that in year two
[the capital expenditure] reaches almost $200 million. She
observed that in this type of development the company would
approach [Version P's] proposed $200 million cap, whereas that
cap was $25 million in the original bill. She asked Mr. Mayer
for his thoughts on what the impact would be if the cap was
somewhere in between those two numbers.
MR. MAYER answered that the thing to remember is that the cap is
on the refundability of the credit and the credit itself is 25
percent under existing statute and under the original bill, and
is 10 percent under Version P. If it is assumed that the peak
spending year, the second year, of development is almost $200
million, then a 25 percent net operating loss credit would be
$50 million and a 10 percent net operating loss credit would be
$20 million.
MR. MAYER noted that he had finished his presentation and was
available for questions.
3:54:57 PM
CO-CHAIR NAGEAK advised that committee members have until March
21, at 5:00 p.m. to review and propose amendments. All
amendments must be drafted by Legislative Legal Services and
Research Services based on [Version P], and given to both co-
chair's offices.
3:55:22 PM
REPRESENTATIVE CHENAULT asked whether the committee will meet at
1:00 p.m. on Monday to hear from the administration.
CO-CHAIR NAGEAK agreed, and said the committee is scheduled to
hear from the Department of Revenue on [Version P].
3:55:49 PM
REPRESENTATIVE SEATON requested that at some point the committee
give consideration as to whether the state would really want to
invest its limited resources in a scenario of no market for the
gas. The state would be expending tons of money that it would
never recover in any price scenario. In his opinion, this type
of project [a new development in a constrained market] should be
taken off the list. If there is not a market identified for the
gas so that once the wells are drilled the producer can sell
that gas, then he does not think the state, in its constrained
fiscal system, can be putting money into a development from
which the state will never recover its resources.
CO-CHAIR NAGEAK responded, "So noted."
3:57:15 PM
REPRESENTATIVE TARR remarked that under Version P there would be
great variability in the provisions depending upon if the
location is the North Slope, Middle Earth, or Cook Inlet. She
asked Mr. Mayer whether that variability is a cause for concern,
given it is often heard that it is important to have
predictability and durability in the state's systems.
MR. MAYER replied that having two different fiscal regimes by
itself is not a cause for concern. Many places have distinct
defined regimes that apply to either distinct geographic areas,
distinct types of production, or other distinctions. It is very
clear, he said, that the basic fiscal regime in Cook Inlet is
not sustainable and is unresolved, and trying to resolve that
sooner rather than later is very important to the ongoing
ability to attract investment into that basin.
3:59:10 PM
REPRESENTATIVE JOSEPHSON understood that Mr. Mayer just stated
it is not sustainable in Cook Inlet and then said something
about incentivizing development into that basin. He requested
Mr. Mayer to restate what he said.
MR. MAYER noted that slide 3 shows the picture of revenue and
spending in Cook Inlet versus the picture of revenue and
spending on the North Slope. He said he does not think anyone
can look at that picture and think that it is a sustainable
picture. A certain amount can be done at the moment simply
through trying to lay back some of those credits, but in the
long run for the health of ongoing investment, producers need to
understand that all of these questions are resolved not just in
terms of marginal changes here or marginal changes there, but
from an overall look at the Cook Inlet fiscal regime and the
ability to set a regime for the long term that everyone thinks
is both fair and stable and durable.
[HB 247 was held over.]