Legislature(2007 - 2008)BARNES 124

03/28/2007 01:00 PM RESOURCES

Download Mp3. <- Right click and save file as

* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
Heard & Held
Scheduled But Not Heard
Scheduled But Not Heard
Scheduled But Not Heard
+ Bills Previously Heard/Scheduled TELECONFERENCED
Moved CSHB 186(FSH) Out of Committee
Heard & Held; Assigned to Subcommittee
HB 128-OIL & GAS PRODUCTION TAX: EXPENDITURES                                                                                 
1:11:18 PM                                                                                                                    
CO-CHAIR GATTO  announced that the  next order of  business would                                                               
be  HOUSE BILL  NO.  128,  "An Act  relating  to allowable  lease                                                               
expenditures for  the purpose of  determining the  production tax                                                               
value  of  oil and  gas  for  the purposes  of  the  oil and  gas                                                               
production tax;  and providing for  an effective date."   [Before                                                               
the  committee was  CSHB 128(O&G),  as amended  at the  March 23,                                                               
2008, hearing.]                                                                                                                 
1:12:44 PM                                                                                                                    
BERNARD HAJNY,  Manager, Production Tax and  Royalties Alaska, BP                                                               
Exploration  Alaska,  paraphrased   from  the  following  written                                                               
testimony [original punctuation provided]:                                                                                      
     I  would  like  to  clarify  that  my  testimony  today                                                                    
     focuses  on  the specific  provisions  of  HB 128,  and                                                                    
     their impact  on the new  Petroleum Production  Tax, or                                                                    
     "PPT,"  from  my  perspective   as  someone  within  BP                                                                    
     charged   with  complying   with   it.  I   am  a   tax                                                                    
     professional, and  not an expert in  Oil Transit Lines,                                                                    
     corrosion,  pipeline  operations  or  pigging;  and  it                                                                    
     would  be  inappropriate for  me  to  talk about  those                                                                    
     areas. I am  here to talk about House Bill  128 and its                                                                    
     implications  for   BP  as  one  of   Alaska's  largest                                                                    
     Last   month  senior   BP   technical  and   operations                                                                    
     management,  Tony Brock  and Mike  Utsler, updated  the                                                                    
     Legislature  on the  status of  our efforts  to address                                                                    
     the issues  we discovered at  Prudhoe Bay last  year. I                                                                    
     can confirm  that both Tony  and Mike are  available in                                                                    
     the  future  should   this  Committee  require  further                                                                    
     updates   on  the   technical  and   operations  issues                                                                    
     relating to Prudhoe Bay.                                                                                                   
1:14:18 PM                                                                                                                    
     There are  two slides for my  presentation today, which                                                                    
     are printed  out on the  front and back of  a one-sheet                                                                    
     handout that  has been distributed to  you. Please look                                                                    
     at  the first  slide on  my handout,  which is  the one                                                                    
     entitled  "BP  Presentation   to  the  House  Resources                                                                    
     The PPT is working for the  State of Alaska, and I mean                                                                    
     "working" in  three senses  of the  term. First,  it is                                                                    
     "working" in the sense that  the PPT regulations by the                                                                    
     Department of  Revenue clarify in several  crucial ways                                                                    
     how the pieces of the  PPT fit together. Taxpayers know                                                                    
     what  is  expected  of them  in  computing  and  making                                                                    
     monthly installment payments, and  in making the annual                                                                    
     true-up on March 31st of the following year.                                                                               
     Second, the PPT is "working"  in the sense of providing                                                                    
     a major increase in state  production tax revenues last                                                                    
     year. For  BP, its  production tax nearly  tripled from                                                                    
     about  $180  million  under  the  old  [economic  limit                                                                    
     factor] ELF-based tax for the  last nine months of last                                                                    
     year,  to over  $500 million  under the  PPT for  those                                                                    
     months. This  is fully in  line with  the Legislature's                                                                    
     expectations about the PPT's revenue effects.                                                                              
     Third, the  PPT has  promise to  "work" in  response to                                                                    
     the  question  on  my slide  that  asks,  "Will  Alaska                                                                    
     attract  sufficient   investment  to   stem  production                                                                    
     decline?"   The   bulk   of  the   known   and   likely                                                                    
     opportunities  in Alaska  for  investing in  production                                                                    
     are  concentrated in  the existing  fields  - that  is,                                                                    
     investing  to  slow  their  decline,  to  increase  the                                                                    
     ultimate recovery  from them,  and to discover  ways to                                                                    
     develop and  produce the 20+  billion barrels  of heavy                                                                    
     and  viscous oil  that are  already known.  The PPT  is                                                                    
     significantly better  suited for  this future  than the                                                                    
     ELF  ever  was. In  addition,  through  its credit  for                                                                    
     capital   expenditures,  it   provides  an   investment                                                                    
     incentive that was absent from the old ELF-based tax.                                                                      
1:16:29 PM                                                                                                                    
MR. HAJNY continued:                                                                                                            
     But  even though  the PPT  structurally has  promise in                                                                    
     attracting the  new investment that  will be  needed to                                                                    
     deal  with  the  threat  of  declining  production,  BP                                                                    
     believes the  PPT is suboptimal  for the  State because                                                                    
     the  tax rate  is  too high.  If you  will  look at  my                                                                    
     second slide  - the graph  on the back of  the one-page                                                                    
     handout - you will find Alaska  at the wrong end of the                                                                    
     spectrum in  terms of government "take"  at the margin.                                                                    
     Investments   in  Alaska   must  compete   successfully                                                                    
     against  opportunities elsewhere,  and by  lowering the                                                                    
     PPT rate  Alaska would increase the  competitiveness of                                                                    
     its  investment  opportunities.   The  production  from                                                                    
     those investments will, we  are convinced, increase the                                                                    
     total revenues from Alaska's  property and income taxes                                                                    
     and royalties  by more  than any  reduction in  the PPT                                                                    
     that might result.                                                                                                         
1:17:26 PM                                                                                                                    
     Now, I would  ask you please to turn back  to the slide                                                                    
     on the  front of  the handout.  HB 128  would introduce                                                                    
     unnecessary  uncertainty into  the PPT.  We agree  with                                                                    
     the  AOGA  testimony  given by  Judy  Brady  about  the                                                                    
     overlap between existing  terms in the PPT  and the new                                                                    
     standard  of "improper"  maintenance  under this  Bill,                                                                    
     which either  makes the Bill  unnecessary or  means its                                                                    
     enactment will  create serious ambiguities. I  will not                                                                    
     repeat that testimony now.                                                                                                 
     Those  questions  about   what  constitutes  "improper"                                                                    
     maintenance only deal  with the matter of  when the new                                                                    
     provisions of HB  128 would be triggered.  What I would                                                                    
     like to  focus on  is what happens  under HB  128 after                                                                    
     that trigger  is pulled.  So I'd ask  you to  imagine a                                                                    
     hypothetical future situation  that indisputably arises                                                                    
     from improper maintenance.                                                                                                 
1:18:15 PM                                                                                                                    
MR. HAJNY continued:                                                                                                            
     If you  look at page 3  of the Bill, beginning  at line                                                                    
     23, you will see  three subparagraphs in paragraph (19)                                                                    
     that  are  designated "(A)",  "(B)"  and  "(C)". It  is                                                                    
     these  subparagraphs that  specify  what happens  after                                                                    
     the improper-maintenance trigger is pulled.                                                                                
     For the moment  I would like to  skip over subparagraph                                                                    
     (A) in  order to  talk about (B)  and (C),  which raise                                                                    
     questions about  sound tax policy. Then  I'll come back                                                                    
     to (19)(A),  which presents an entirely  different kind                                                                    
     of issue.                                                                                                                  
     Subparagraph (19)(B) disallows  any costs determined by                                                                    
     the Commissioner  of Revenue to have  been "incurred to                                                                    
     maintain  the operational  capability of  facilities or                                                                    
     equipment   shut   down   because   of   ...   improper                                                                    
     maintenance of property or equipment[.]"                                                                                   
     The first  thing to  note is  that the  disallowance is                                                                    
     not  limited  to  stand-by costs  for  keeping  up  the                                                                    
     operational  capability of  the  property or  equipment                                                                    
     that  was improperly  maintained.   When  you read  the                                                                    
     Bill closely, you  see that what is  disallowed are the                                                                    
     costs  of  sustaining  the  operational  capability  of                                                                    
     shut-down "facilities or  equipment", while the trigger                                                                    
     is  improper  maintenance  of "property  or  equipment"                                                                    
     (emphasis added). Because  these phrases are different,                                                                    
     they cover  different things.  In other  words, (19)(B)                                                                    
     would permit  disallowance of all costs  of standing by                                                                    
     and  staying  ready to  resume  production  - even  the                                                                    
     portion of stand-by costs  for facilities and equipment                                                                    
     that were properly maintained.                                                                                             
1:19:51 PM                                                                                                                    
MR. HAJNY continued:                                                                                                            
     Does this make sense?  (19)(B) penalizes spending money                                                                    
     to   "maintain    ...   operational    capability"   by                                                                    
     disallowing those  costs. I hope  that we would  want a                                                                    
     field to  get back up  and running as soon  as possible                                                                    
     after a shut-down,  but (19)(B) will be  an obstacle to                                                                    
     Subparagraph   (19)(C)    similarly   disallows   costs                                                                    
     determined  by  the  Commissioner   of  Revenue  to  be                                                                    
     "incremental  operating expenses  incurred as  a result                                                                    
     of  operating  facilities  or equipment  at  diminished                                                                    
     capacity  when that  diminished capacity  is caused  by                                                                    
     ...  improper maintenance  of  property or  equipment."                                                                    
     Here,  again,  the  disallowance   is  not  limited  to                                                                    
     diminished  capacity  of  the "property  or  equipment"                                                                    
     that   was   improperly    maintained,   but   includes                                                                    
     diminished  capacity of  any  "operating facilities  or                                                                    
     equipment"(emphasis added).                                                                                                
     Does this make  sense from a tax policy  point of view?                                                                    
     Again,  I  don't think  so.    Subparagraph (19)(C)  is                                                                    
     effectively  saying that  if  it costs  more  to run  a                                                                    
     field at  diminished capacity, the  State will  deter a                                                                    
     producer from  doing so by  disallowing those  costs. I                                                                    
     should   think  that   having  part   of  a   field  in                                                                    
     production,  even  at  a  higher-than-normal  operating                                                                    
     cost, is better  than having it completely  shut down -                                                                    
     especially in  light of state royalties  and income tax                                                                    
     which  are  both  enhanced  by  keeping  the  field  in                                                                    
     production.  If anything,  (19)(C)  should be  reducing                                                                    
     the PPT as an incentive for  keeping as much of a field                                                                    
     in production  as possible, but  it does  precisely the                                                                    
     opposite instead.                                                                                                          
     Thus,  I submit,  both (19)(B)  and (19)(C)  go off  in                                                                    
     exactly  the wrong  direction from  what  is sound  tax                                                                    
     policy for the State, and  both of them should be taken                                                                    
     out of the Bill.                                                                                                           
1:21:40 PM                                                                                                                    
MR. HAJNY continued:                                                                                                            
     This gets me back to  subparagraph (19)(A) on page 3 of                                                                    
     the Bill  at lines  23 - 24.   Under  this subparagraph                                                                    
     any costs determined by the  Commissioner of Revenue to                                                                    
     be  "related  to  the repair  or  replacement"  of  the                                                                    
     improperly   maintained  property   or  equipment   are                                                                    
     disallowed. The  problem with this new  disallowance is                                                                    
     that  it "double-dips"  on  the  flat-rate 30  cents-a-                                                                    
     barrel  disallowance under  paragraph (18).  Judy Brady                                                                    
     has explained  how this  30-cent disallowance  by Pedro                                                                    
     van Meurs was  directed at exactly the  same issue that                                                                    
     (19)(A)   addresses,  and   how   the  Senate   Special                                                                    
     Committee on  Natural Gas  Development then  rejected a                                                                    
     proposal like (19)(A)  twice in favor of  the van Meurs                                                                    
     flat rate  disallowance in paragraph  (18). I  will not                                                                    
     repeat those details now.                                                                                                  
     Even paragraph  (18) went too far  and was ill-advised.                                                                    
     Other provisions  in the PPT  law already  address, and                                                                    
     deal  with, the  questions about  adequate maintenance,                                                                    
     and  do  so  in  a  fair and  reasonable  way.  If  the                                                                    
     objective  is to  make the  PPT  a better  law for  the                                                                    
     future,  then  HB  128 should  repeal  paragraph  (18).                                                                    
     Instead, the  Bill proposes to  compound the  error not                                                                    
       only by keeping paragraph (18), but also by adding                                                                       
      subparagraph (19)(A) to double-dip on the very same                                                                       
     costs that paragraph (18) already disallows.                                                                               
       This concludes our testimony on HB 128. Thank you                                                                        
     again for this opportunity to appear before you.                                                                           
1:23:15 PM                                                                                                                    
MR.  HAJNY, in  response to  Co-Chair Gatto,  explained that  the                                                               
$.30 is calculated  such that $.30 a barrel is  multiplied by the                                                               
total number  of barrels  produced.   That dollar  amount reduces                                                               
both the  capital expenses and  the lease expenditures,  and thus                                                               
reduces   the  opportunity   for  a   deduction  and   a  credit.                                                               
Therefore, it reduces the deduction  against the 22.5 percent tax                                                               
rate as well as against the  20 percent credit.  He recalled that                                                               
Dr. van  Meurs estimated that the  $.30 will amount to  about $40                                                               
million at 900,000  barrels a day; $40 million  that the industry                                                               
wouldn't be  allowed to deduct as  costs or to obtain  as credits                                                               
under the PPT.  He opined that  Dr. van Meurs was trying to point                                                               
out  that  there  are  going  to  be  expenditures  dealing  with                                                               
maintenance  and  specific  issues  for  which  the  $.30  is  to                                                               
1:26:09 PM                                                                                                                    
REPRESENTATIVE  WILSON, referring  to paragraph  (18) on  page 3,                                                               
lines  13-18,  pointed out  that  in  the  future there  will  be                                                               
increases  in  inflation  and  increased  costs  to  fix  things.                                                               
Therefore,  it's probably  not in  the state's  best interest  to                                                               
leave it as  a flat amount because in the  long-term someone will                                                               
be responsible for paying the remainder beyond the flat rate.                                                                   
1:27:19 PM                                                                                                                    
CO-CHAIR  GATTO  asked  if  BP  made  more  money  the  year  the                                                               
petroleum  production profits  tax  (PPT)  was implemented,  even                                                               
though the taxes tripled.                                                                                                       
MR.  HAJNY  responded that  BP  estimates  that its  taxes  would                                                               
nearly  triple from  $180  million  under the  ELF  to over  $500                                                               
million [under  the PPT].  However,  he said that he  didn't know                                                               
BP Alaska's net income or  income figures during that same period                                                               
for 2006.   He acknowledged that  oil prices were higher  in 2006                                                               
than in the prior year.                                                                                                         
1:28:50 PM                                                                                                                    
CO-CHAIR GATTO  commented that he  was curious as to  whether the                                                               
state and the  companies both made money under the  PPT.  He said                                                               
that he's trying  to ascertain whether the effect of  the PPT was                                                               
truly devastating or somewhat negative.                                                                                         
MR. HAJNY  explained that the  point BP  tried to make  last year                                                               
during the  PPT hearings was  that increasing the tax  won't make                                                               
Alaska  more competitive  in  the  basins where  oil  and gas  is                                                               
produced.   In  further  response to  Co-Chair  Gatto, Mr.  Hajny                                                               
pointed out  BP's graph shows  that the marginal take  for Alaska                                                               
is higher  than the  provinces, which are  generally oil  and gas                                                               
provinces, that BP has represented.                                                                                             
1:29:56 PM                                                                                                                    
CO-CHAIR GATTO  asked if  the federal  government also  made more                                                               
money as compared to the prior year.                                                                                            
MR. HAJNY  surmised that if  the net  income rises, the  tax rate                                                               
would increase.                                                                                                                 
CO-CHAIR GATTO  opined then that  part of the government  take is                                                               
an increase  in the federal  government take, not just  the state                                                               
government's take.                                                                                                              
MR. HAJNY replied  yes, adding that all  provinces would've risen                                                               
at the same level.                                                                                                              
1:30:44 PM                                                                                                                    
REPRESENTATIVE  SEATON  referred  to  the chart  from  BP  titled                                                               
"Alaska  has  adopted the  highest  marginal  tax rate  in  North                                                               
America".  He  asked whether the chart for  Colorado, Kansas, and                                                               
Texas included the private royalties that are paid.                                                                             
MR. HAJNY  replied yes, and  specified that the chart  includes a                                                               
one-eighth or 12.5  percent royalty across the board  in order to                                                               
have an apples-to-apples comparison.                                                                                            
1:31:17 PM                                                                                                                    
REPRESENTATIVE  SEATON, referring  to paragraph  (19) on  page 3,                                                               
asked if shut  downs due to preventive maintenance  could be said                                                               
to  have  been   due  to  improper  maintenance,   and  thus  the                                                               
incremental cost of  operating the field with a  portion of wells                                                               
shut down wouldn't be deductible.                                                                                               
MR. HAJNY replied yes.   Therefore, BP reads the legislation such                                                               
that  if an  auditor  determines that  a portion  of  a piece  of                                                               
equipment was  improperly maintained or installed,  the operating                                                               
costs while the  field is down could be  disallowed as deductible                                                               
1:32:51 PM                                                                                                                    
REPRESENTATIVE SEATON related his  understanding that quite often                                                               
a portion of  a field's wells are shut down  for maintenance.  He                                                               
surmised then that  if it's determined that wells  were shut down                                                               
because  they should've  been  maintained  differently, then  the                                                               
incremental costs of operating the field wouldn't be deductible.                                                                
MR. HAJNY  noted his agreement  with Representative Seaton.   For                                                               
example, in a  situation in which a seal or  gasket was installed                                                               
backwards, the  language in [paragraph  (19)] says that  the cost                                                               
associated  with   the  whole   compression  facility   could  be                                                               
disallowed as  well as the  associated operating costs  while the                                                               
company tries to fix it.                                                                                                        
1:34:42 PM                                                                                                                    
CO-CHAIR  JOHNSON  asked  if  the  $.30  is  deductible  for  the                                                               
company's federal income taxes.                                                                                                 
MR. HAJNY  clarified that the $.30  is an ordinary cost  of doing                                                               
business and would be deductible.                                                                                               
1:35:20 PM                                                                                                                    
CO-CHAIR  JOHNSON  inquired  as  to   whether  the  rest  of  the                                                               
maintenance would fall  under the category of  a regular business                                                               
expense and be deductible from the federal income tax.                                                                          
MR. HAJNY,  noting that he  is not  a federal income  tax expert,                                                               
related   his  understanding   that  these   would  normally   be                                                               
deductible costs.                                                                                                               
1:35:53 PM                                                                                                                    
CO-CHAIR JOHNSON asked:                                                                                                         
     Will that  effect the 67 percent  take - if you  get to                                                                    
     deduct  these expenses  from your  federal income  tax,                                                                    
     will that  reduce that take?  ... If I  understand you,                                                                    
     the  $.30 is  deductible, the  maintenance ...  that is                                                                    
     performed  ... regardless  how  ...  we categorize  the                                                                    
     maintenance.    Will  that deduction  decrease  the  67                                                                    
     percent, in your opinion?                                                                                                  
MR. HAJNY answered that he didn't know.                                                                                         
1:36:32 PM                                                                                                                    
CO-CHAIR  GATTO  surmised that  if  a  company  has $1  worth  of                                                               
maintenance and  the state  doesn't allow  the $.30,  the company                                                               
spends the $1 and the company declares the $1.                                                                                  
1:37:24 PM                                                                                                                    
CO-CHAIR JOHNSON inquired as to  why the company wouldn't declare                                                               
$1.30 since  the $.30 is  already included  as a regular  part of                                                               
daily business.                                                                                                                 
CO-CHAIR GATTO noted  his disagreement, stating that  the $.30 is                                                               
a fictitious number  until the company pays a bill.   The $.30 is                                                               
only allowed  to offset  an expense.   Therefore, if  the company                                                               
doesn't offset an expense, the $.30 never existed, he opined.                                                                   
1:38:22 PM                                                                                                                    
MR.  HAJNY   related  his  understanding   that  the   costs  are                                                               
determined under  the Internal  Revenue Service  (IRS) guidelines                                                               
and not subject to what occurs under the PPT.                                                                                   
1:39:10 PM                                                                                                                    
GARY ROGERS,  Production Audit Manager, Tax  Division, Department                                                               
of  Revenue  (DOR),  related his  understanding  that  $1  spent,                                                               
expense or capital, the IRS  recognizes that as a $1 expenditure.                                                               
The IRS doesn't recognize the  $.30 that's a disallowance of that                                                               
$1 for the PPT.                                                                                                                 
1:40:20 PM                                                                                                                    
REPRESENTATIVE SEATON clarified that  the deductions can be taken                                                               
against the  PPT, federal income  tax, and the  state's corporate                                                               
income  tax.     Therefore,   these  aren't   mutually  exclusive                                                               
deductions.  The only way to  achieve a higher amount, he opined,                                                               
is based on  the credits that are allowed for  capital.  When the                                                               
credits are  allowed, an entity  can receive a credit  portion of                                                               
that entity's  investment.   In that some  additional tax  can be                                                               
achieved, he noted.                                                                                                             
1:41:22 PM                                                                                                                    
CO-CHAIR GATTO reminded  the committee that this  is really about                                                               
defining improper  maintenance.   He said  he's depending  on the                                                               
testimony  from  the  companies   to  relate  what  they  believe                                                               
constitutes proper maintenance.                                                                                                 
1:43:35 PM                                                                                                                    
REPRESENTATIVE  ROSES  recalled  testimony  in  which  there  was                                                               
discussion   regarding   the   following   four   categories   of                                                               
negligence:  intentional or willful  neglect; gross negligence or                                                               
disregard  to  the consequences  that  could  occur; ordinary  or                                                               
common negligence;  and strict liability.   The  testimony seemed                                                               
to indicate that  HB 128 is creating a definition  of ordinary or                                                               
common negligence and  the result of that.   Representative Roses                                                               
opined, "I think part of what  we're getting to here is trying to                                                               
define what occurred by plugging up  what we see as a loop hole."                                                               
He  then  asked  if  during  a  partial  shut  down  for  regular                                                               
maintenance, a company  would replace equipment that  is found to                                                               
be faulty or leave it until it stops working.                                                                                   
MR. HAJNY said  that he would be venturing into  an area in which                                                               
he's not familiar.                                                                                                              
1:46:55 PM                                                                                                                    
REPRESENTATIVE  ROSES related  his guess  that the  company would                                                               
probably replace  that faulty equipment.   If the  company didn't                                                               
replace  it, he  opined  that  it would  be  ordinary and  common                                                               
negligence.  According  to this legislation, the  company in such                                                               
a  circumstance wouldn't  be  able  to deduct  any  of the  costs                                                               
related  due  to   the  partial  shut  down.     On  the  surface                                                               
Representative  Roses noted  his  agreement with  Mr. Hajny  that                                                               
this is a bit excessive  in that the state encourages maintenance                                                               
but   punishes  the   company  when   it   does.     Furthermore,                                                               
Representative Roses said that he isn't fond of retroactivity.                                                                  
1:48:09 PM                                                                                                                    
REPRESENTATIVE    GUTTENBERG   requested    further   explanation                                                               
regarding  Mr.   Hajny's  assertion  that  the   PPT  had  higher                                                               
incentives for investment than the ELF.                                                                                         
MR. HAJNY clarified  that he's referring to  the deductibility of                                                               
the   expenses   and   the  credits   associated   with   capital                                                               
expenditures.     The  intent  appeared  to   be  to  incentivize                                                               
investment,  and therefore  try  to  incentivize investment  that                                                               
would  stem  the decline  in  Alaska,  he  related.   In  further                                                               
response  to Representative  Guttenberg, Mr.  Hajny said  that he                                                               
didn't know what the world average  is; the point of the slide is                                                               
that Alaska  would be well-served  to move in the  direction that                                                               
the Gulf of Mexico, Canada, and  Alberta are with regard to their                                                               
tax regimes and marginal rates.                                                                                                 
1:50:02 PM                                                                                                                    
REPRESENTATIVE SEATON, referring to page  3, line 19, inquired as                                                               
to Mr.  Hajny's understanding of the  "costs" as a standard.   He                                                               
then asked if there's a criteria  or is it merely a determination                                                               
that the commissioner can make at any given time.                                                                               
MR.  HAJNY said  that  Representative Seaton  has identified  the                                                               
biggest issue,  the potential ambiguity and  uncertainty, that BP                                                               
has with this legislation.                                                                                                      
1:51:29 PM                                                                                                                    
REPRESENTATIVE  SEATON inquired  as to  how [the  companies] will                                                               
project the replacement and maintenance  of equipment since these                                                               
characteristics are  not going to  be incident driven  but rather                                                               
audit driven.   He  recalled that  DOR has said  that one  of the                                                               
criteria used  by an auditor  would be a  high expense.   "Do you                                                               
feel  that under  this, it's  going to  be necessary  to maintain                                                               
that  piece of  equipment that's  been replaced  so that  you can                                                               
verify  that you  didn't  replace it  because  it was  improperly                                                               
maintained," he asked.  He  explained that he's trying to address                                                               
how  to   determine  whether  or   not  something   was  properly                                                               
maintained or not since this is  likely driven by an audit or tax                                                               
return  and will  be  a  capital expenditure,  "it  will be  long                                                               
MR. HAJNY  confirmed that the  aforementioned, the fact  that the                                                               
audits are  retrospective, is one  of the  difficulties companies                                                               
will have with  administering this.  Companies  will deduct costs                                                               
and  apply  credits  associated with  expenditures  as  they  are                                                               
spent.   The determination  of whether that  was replaced  due to                                                               
improper  maintenance  would   potentially  be  determined  years                                                               
later.  Trying to provide  information that would prove equipment                                                               
was  properly maintained  accompanied  with the  burden that  the                                                               
companies would  be against during  the audit could  be difficult                                                               
to document.                                                                                                                    
1:54:03 PM                                                                                                                    
CO-CHAIR GATTO commented that this  reminds him of court hearings                                                               
in which one can only be proven to be not guilty, not innocent.                                                                 
1:56:27 PM                                                                                                                    
MICHAEL   HURLEY,  Director,   of  State   Government  Relations,                                                               
ConocoPhillips  Alaska,   Inc.,  said   that  he   would  discuss                                                               
ConocoPhillips  Alaska, Inc.  (ConocoPhillips)  opposition to  HB
128.   As discussed in  a prior  hearing, Mr. Hurley  opined that                                                               
it's appropriate for  the legislature to determine  what it wants                                                               
to allow  or disallow under  the PPT.   However, Mr.  Hurley said                                                               
that he  believes the  $.30 can  be shown as  related to  and, in                                                               
fact,  because of  the incidents  that occurred  at Prudhoe  Bay.                                                               
The current  legislation seeks to duplicate  that disallowance in                                                               
a  different way.   He  suggested  that the  legislature has  the                                                               
responsibility to decide which way to disallow it.                                                                              
1:58:38 PM                                                                                                                    
REPRESENTATIVE WILSON  interjected that she misspoke  earlier and                                                               
in fact it's the opposite of what she said.                                                                                     
1:58:52 PM                                                                                                                    
MICHAEL  FRALEY,   Tax  Counsel,  ConocoPhillips   Alaska,  Inc.,                                                               
related that ConocoPhillips opposes  HB 128 for multiple reasons.                                                               
The  first reason  is that  ConocoPhillips believes  HB 128  is a                                                               
targeted  tax.   He  pointed out  that  AS 43.56.165(e)  includes                                                               
numerous  exclusions  that  reduce  lease  expenditures.    Those                                                               
disallowances   of   the   lease  expenditures   were   discussed                                                               
throughout  the   regular  session  as  well   as  three  special                                                               
sessions.   It wasn't until  the August 3, 2006,  special session                                                               
that AS 43.56.165(e)(18)  was discussed, which was  after the oil                                                               
spill became public.  He  noted that AS 43.56.165(e)(19) was also                                                               
discussed at the time, but  ultimately the legislature decided to                                                               
implement  AS 43.56.165(e)(18),  which  is  a broad  disallowance                                                               
versus a narrowly tailored disallowance.   Mr. Fraley opined that                                                               
a targeted tax is a bad way to  set tax policy.  Second, it's too                                                               
early to  reopen the PPT as  companies are just now  filing final                                                               
returns  for  the  last  nine   months  of  2006.    Furthermore,                                                               
regulations   have   not   yet    been   promulgated.      Third,                                                               
ConocoPhillips believes that existing  statute already covers the                                                               
issue addressed by HB 128.                                                                                                      
2:01:56 PM                                                                                                                    
MR.  HURLEY,  referring to  the  document  titled "30  Cents  per                                                           
Barrel Disallowance  Example", explained the PPT  calculation and                                                           
reviewed  an example  of the  PPT  under ConocoPhillips'  average                                                               
barrel of  oil last year, which  was $62.66.  In  response to Co-                                                               
Chair Gatto, Mr.  Hurley specified that the tariff  was taken out                                                               
prior to  arriving at the $62.66,  which is the value  of the oil                                                               
at  the lease  line.   He explained  that the  value on  the West                                                               
Coast minus transportation  gets to the lease line,  the point at                                                               
which  the  costs  and  investments   are  subtracted.    In  the                                                               
calculation,  the tariff  last year  was in  the range  of $4.25-                                                               
$4.50.    In  further  response to  Co-Chair  Gatto,  Mr.  Hurley                                                               
specified that the interstate rate is currently between $5.00-                                                                  
$5.50.  Mr. Hurley confirmed  that the [interstate rate] is still                                                               
an issue that's being resolved.                                                                                                 
2:04:49 PM                                                                                                                    
MR. HURLEY  continued his  review of the  PPT calculation  in the                                                               
case of  an average  barrel of  oil at  $62.66, which  results in                                                               
$9.98 a  barrel of tax,  absent other items.   He noted  that the                                                               
tax is  actually higher than  that because  of the surtax.   When                                                               
the $.30  comes into  play, it's  subtracted from  the investment                                                               
and that's  what the company is  allowed to claim on  its PPT tax                                                               
return although  it spent $.30 more  than is allowed.   The final                                                               
tax return in this example  illustrates that the $.30 is deducted                                                               
in  two places,  and thus  instead of  paying $9.98  in severance                                                               
tax,  ConocoPhillips  would  pay   $10.11  because  of  the  $.30                                                               
2:06:53 PM                                                                                                                    
CO-CHAIR GATTO surmised  then that in this example  with the $.30                                                               
disallowance, ConocoPhillips' tax increased by 1 percent.                                                                       
MR. HURLEY  specified that  the tax increase  was on  111 million                                                               
barrels,  which  amounts  to  about  $14.5-$15  million  in  this                                                               
2:07:42 PM                                                                                                                    
MR.  FRALEY  highlighted   that  ConocoPhillips  will  experience                                                               
additional impacts, such  as the 10 percent tie credit.   The tie                                                               
credit  will  be  reduced  for  the  first  five  to  six  years.                                                               
Furthermore,  any   progressivity  would  create   an  additional                                                               
impact.   For simplicity, the  aforementioned wasn't  included in                                                               
the example.                                                                                                                    
MR.  HURLEY explained  that [AS  43.56.165(e)(18)] is  already in                                                               
law to address maintenance.                                                                                                     
2:08:31 PM                                                                                                                    
REPRESENTATIVE ROSES  inquired as to  the percentage of  costs in                                                               
the  first  part of  the  formula  that  would be  attributed  to                                                               
2:08:52 PM                                                                                                                    
MR. HURLEY  said it would  depend on the  field.  For  example, a                                                               
field such as Prudhoe Bay that  started in the 1970s would have a                                                               
more   significant  portion   of  maintenance   costs  versus   a                                                               
relatively  new field  such as  Alpine.   He  clarified that  the                                                               
numbers utilized in the example  are an average number across all                                                               
of ConocoPhillips' fields.                                                                                                      
2:09:31 PM                                                                                                                    
REPRESENTATIVE ROSES  inquired as to  the overall costs  that are                                                               
attributable to maintenance.                                                                                                    
MR. HURLEY  said that he  doesn't know.   In further  response to                                                               
Representative Roses, Mr.  Hurley said he would hope  that if the                                                               
incident-by-incident  approach outlined  in HB  128  is used,  it                                                               
wouldn't get rid  of all maintenance.  The  department would have                                                               
to show what sorts of things were improperly maintained.                                                                        
2:10:51 PM                                                                                                                    
REPRESENTATIVE  ROSES   posed  a  situation  in   which  half  of                                                               
ConocoPhillips' cost is maintenance,  included in which are labor                                                               
costs,  and only  half of  it was  attributable to  some sort  of                                                               
negligence  or shut  down.   The aforementioned  would amount  to                                                               
only one-fourth  of that.   However, if the $9.98  was disallowed                                                               
under  the normal  deduction of  cost,  the cost  of that  barrel                                                               
would be increased  by an additional $.35.   Representative Roses                                                               
opined  that if  ConocoPhillips is  going  to testify  as to  the                                                               
financial impact  this proposal  will have on  the company,  at a                                                               
minimum  he  said  he  expected  some of  the  numbers  would  be                                                               
available.  He said that he's  trying to get a realistic estimate                                                               
as to what percentage of the  costs are maintenance and when must                                                               
a shut down occur to perform  regular maintenance.  Those are the                                                               
times  in which  the possibility  of an  audit could  trigger the                                                               
company's  inability  to  deduct   the  costs  because  of  being                                                               
shutdown due to negligence.                                                                                                     
MR. HURLEY  explained that when  he used this example,  it wasn't                                                               
intended  to make  a case  about how  large the  number is.   The                                                               
example  was only  for illustrative  purposes  regarding how  the                                                               
disallowance works.                                                                                                             
2:13:56 PM                                                                                                                    
REPRESENTATIVE  SEATON  surmised  then   that  the  example  only                                                               
relates to  AS 43.55.165(e)(19)(A), the cost  of maintenance, but                                                               
not to  AS 43.55.165(e)(19)(B)  or AS  43.55.165(e)(19)(C), which                                                               
have  to  do  with  the  costs  of  operation  if  something  was                                                               
determined  to be  improperly maintained.    Therefore, the  $.30                                                               
can't be  related to  direct cost  because it's  the cost  of the                                                               
nonmaintained  items,  plus  a shut  down  or  reduced  operating                                                               
2:14:46 PM                                                                                                                    
MR. HURLEY  clarified that $.30  isn't in AS  43.55.165(e)(19) at                                                               
all,  but rather  in existing  law  in AS  43.55.165(e)(18).   He                                                               
further clarified  that the aforementioned already  exists and is                                                               
deducted from  the PPT  filings every month.   Therefore,  HB 128                                                               
includes  an additional  disallowance on  an incident-by-incident                                                               
basis  based  on subsections  (a)-(c)  over  and above  the  $.30                                                               
that's already being disallowed.                                                                                                
2:15:44 PM                                                                                                                    
CO-CHAIR  GATTO  recalled that  Mr.  Fraley  objected to  HB  128                                                               
because it's a targeted tax.   Co-Chair Gatto pointed out various                                                               
taxes that  are targeted  taxes, including  the cruise  ship tax,                                                               
the fuel tax,  the tire tax, a business license,  a sales tax, or                                                               
income tax.   He asked Mr. Fraley to name  some taxes that aren't                                                               
MR. FRALEY remarked  that the taxes Co-Chair  Gatto mentioned are                                                               
generally  applicable  to  the  industry,  and  therefore  aren't                                                               
targeted taxes.   He  related that his  definition of  a targeted                                                               
tax  is  one in  which  the  tax is  created  due  to a  specific                                                               
2:16:47 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  inquired as to the  level of incidence                                                               
to  which something  has  to  arise and  cause  this  to go  into                                                               
MR. FRALEY commented that one  of the problems ConocoPhillips has                                                               
with HB  128 is  that it  is unknown;  no certainty  is involved.                                                               
"There's an imprecise standard, and then  on top of that we don't                                                               
know it's going to be applied  and how it's going to be applied,"                                                               
he opined.   Therefore, it's  an unknown cost  for ConocoPhillips                                                               
and contributes to the opposition to HB 128.                                                                                    
2:17:53 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  reminded everyone that last  year when                                                               
the  PPT  was  passed,  the   general  assumption  was  that  the                                                               
incidents causing these (indisc.)  and repair costs weren't going                                                               
to be  deductible.   However, now the  legislature is  being told                                                               
that they will be deducted.   He then recalled hearing that under                                                               
the  old ELF  program there  were  few incentives  and that  when                                                               
companies  had  cash in  hand,  they  [didn't deduct  the  repair                                                               
costs].   However, there was  an incident when the  companies had                                                               
cash in  hand and  the proper maintenance  wasn't performed.   He                                                               
opined that  to reach  a level  at which this  would kick  in, it                                                               
would have  to be a fairly  high level.  The  concern, he opined,                                                               
is  when the  field  shuts  down, the  pipe  is  corroded, and  a                                                               
significant amount of revenues are impacted.                                                                                    
2:20:18 PM                                                                                                                    
REPRESENTATIVE SEATON directed attention to  page 3, line 19, and                                                               
inquired  as to  whether  that language  has  any direction  with                                                               
regard to what will be disallowed.                                                                                              
MR.  FRALEY  echoed  earlier comments  that  the  language  seems                                                               
ambiguous  and  penalizes  an  operator  who  tries  to  maintain                                                               
facilities  and  equipment even  when  there's  a shutdown.    He                                                               
stressed that  operators who operate  at a reduced  capacity will                                                               
be penalized for doing so.                                                                                                      
2:21:20 PM                                                                                                                    
REPRESENTATIVE SEATON  surmised then that within  the legislation                                                               
there's no standard or direction for a determination.                                                                           
MR.  HURLEY noted  that they  never reached  their fourth  point,                                                               
which  is that  some of  the ambiguity  in the  way in  which the                                                               
legislation is  constructed is troublesome  and that is one.   He                                                               
pointed out  that portion of cost  doesn't provide a guide  as to                                                               
which portion  of the  costs "we're  trying to  figure out."   He                                                               
highlighted  that it's  difficult  to tell  what  portion of  the                                                               
costs are  from improper  maintenance or  regular wear  and tear.                                                               
The  aforementioned is  impossible  to know,  and thus  companies                                                               
wouldn't know  how to file their  returns and thus would  have to                                                               
be  brought forth  under  an  audit that  occurs  later when  the                                                               
different standard is applied.                                                                                                  
2:22:51 PM                                                                                                                    
MR. FRALEY turned  to ConocoPhillips' third point,  which is that                                                               
there  are  already protections  in  statute.   For  example,  AS                                                               
43.55.165(e)(16)  disallows  the  deduction   of  any  oil  spill                                                               
cleanup costs.   Furthermore, AS 43.55.165(e)(6)  discusses gross                                                               
negligence  and any  maintenance  issue due  to gross  negligence                                                               
wouldn't be deducted either.                                                                                                    
2:23:17 PM                                                                                                                    
CO-CHAIR GATTO related  his understanding when a  company has oil                                                               
spill  cleanup  costs,  it  would  have to  have  in  place  much                                                               
equipment in order  to perform the cleanup.   Therefore, he asked                                                               
if  the industry  of cleaning  up the  oil would  be part  of the                                                               
capital expenses that are all deductible.                                                                                       
2:23:41 PM                                                                                                                    
MR.  HURLEY clarified  that [cleanup  equipment] is  part of  the                                                               
companies'  normal  operating  costs.     The  company  pays  for                                                               
response vessels through a co-op  amongst the different operators                                                               
such  that  it's available  when  an  incident actually  happens.                                                               
When there  is an incident  and vessels and cleanup  products are                                                               
used, the company  with the spill has to resupply  the co-op with                                                               
all  the  items  that  it  used, which  isn't  a  deductible  PPT                                                               
expense.  In further response  to Co-Chair Gatto, Mr. Hurley said                                                               
that the cleanup items were purchased several years ago.                                                                        
2:25:09 PM                                                                                                                    
MR.  FRALEY   then  directed  attention   to  a   handout  titled                                                               
"Disallowing  'deemed capital  maintenance'  costs" which  offers                                                           
another explanation of  how AS 43.55.165(e)(19) works.   He noted                                                               
that this information was derived  from Pedro van Meurs August 8,                                                               
2006, letter.   He highlighted  the following quote from  Dr. van                                                               
Meurs,  "I believe  that  this  would provide  a  good answer  to                                                               
possible public criticism that under  the PPT we would provide 50                                                               
percent of the replacement costs of  pipelines as a result of the                                                               
Prudhoe Bay shut down."                                                                                                         
2:26:17 PM                                                                                                                    
REPRESENTATIVE  ROSES  remarked  that  there are  parts  of  this                                                               
legislation  that he  doesn't  like at  all.   He  noted that  he                                                               
agrees  that there  is already  negligence and  other factors  in                                                               
place  that disallow  [the  deduction of  the  costs of  improper                                                               
repair  and/or   maintenance].    This  legislation   places  the                                                               
negligence  at  the level  of  ordinary  negligence, which  is  a                                                               
lesser requirement of  proof for negligence.  He said  that he is                                                               
seeking  numbers  that relate  the  tax  ramifications on  a  per                                                               
barrel  basis as  it provides  something  by which  to weigh  the                                                               
MR.  FRALEY offered  to provide  the  committee information  with                                                               
regard to the  percentage of maintenance costs, noting  that as a                                                               
field ages  there are  more maintenance  costs for  those fields.                                                               
With  regard  to  how  much  of the  maintenance  costs  will  be                                                               
disallowed, Mr.  Fraley reiterated  that he  doesn't know.   With                                                               
regard   to  the   actual  language   of   the  legislation,   AS                                                               
43.55.165(e)(19) seems to specify that  the final arbiter will be                                                               
accountants and  attorneys at  DOR rather  than engineers  at the                                                               
Alaska  Oil  and  Gas   Conservation  Commission  (AOGCC),  which                                                               
creates further uncertainty.                                                                                                    
2:29:07 PM                                                                                                                    
REPRESENTATIVE GUTTENBERG  surmised that  there's a  problem with                                                               
defining with  what's allowable and  what's disallowable  as well                                                               
as  what   triggers  the  aforementioned.     He   indicated  the                                                               
possibility of  requiring every regularly scheduled  shut down to                                                               
be  reported and  thus  an  unexpected shut  down  would cause  a                                                               
review into whether the proper maintenance was being performed.                                                                 
2:30:22 PM                                                                                                                    
MR. HURLEY  expressed concern  that even  if all  the appropriate                                                               
maintenance is performed, equipment could  still fail.  He opined                                                               
that the investigation of all  equipment failures would amount to                                                               
a lot.                                                                                                                          
REPRESENTATIVE   GUTTENBERG  questioned   the  [feasibility]   of                                                               
investigating shut downs that result in  the loss of revenue.  He                                                               
acknowledged that incidents  occur all the time,  but last year's                                                               
leak due to corrosion wasn't normal.                                                                                            
MR. HURLEY commented that last year's leak was extraordinary.                                                                   
2:31:19 PM                                                                                                                    
CO-CHAIR  GATTO   appointed  a  subcommittee  of   the  following                                                               
members:    Representative  Johnson, Chair,  and  Representatives                                                               
Wilson and Guttenberg.                                                                                                          
2:31:44 PM                                                                                                                    
CO-CHAIR JOHNSON  said that he  is terribly  uncomfortable making                                                               
any decisions  on HB 128  until some real numbers  are available.                                                               
He  expressed the  desire  to  have tax  returns  and the  actual                                                               
expenses and what DNR has decided.                                                                                              
[HB 128 was held over.]                                                                                                         

Document Name Date/Time Subjects