Legislature(2005 - 2006)SENATE FINANCE 532
04/05/2006 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SB305 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 305 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
CS FOR SENATE BILL NO. 305(RES)
"An Act providing for a production tax on oil and gas;
repealing the oil and gas production (severance) tax;
relating to the calculation of the gross value at the point
of production of oil or gas and to the determination of the
value of oil and gas for purposes of the production tax on
oil and gas; providing for tax credits against the tax for
certain expenditures and losses; relating to the
relationship of the production tax on oil and gas to other
taxes, to the dates those tax payments and surcharges are
due, to interest on overpayments of the tax, and to the
treatment of the tax in a producer's settlement with the
royalty owners; relating to flared gas, and to oil and gas
used in the operation of a lease or property under the
production tax; relating to the prevailing value of oil or
gas under the production tax; relating to surcharges on
oil; relating to statements or other information required
to be filed with or furnished to the Department of Revenue,
to the penalty for failure to file certain reports for the
tax, to the powers of the Department of Revenue, and to the
disclosure of certain information required to be furnished
to the Department of Revenue as applicable to the
administration of the tax; relating to criminal penalties
for violating conditions governing access to and use of
confidential information relating to the tax, and to the
deposit of tax money collected by the Department of
Revenue; amending the definitions of 'gas,' 'oil,' and
certain other terms for purposes of the production tax, and
as the definition of the term 'gas' applies in the Alaska
Stranded Gas Development Act, and adding further
definitions; making conforming amendments; and providing
for an effective date."
This was the fifth hearing for this bill in the Senate Finance
Committee.
JIM BOWLES, President, ConocoPhillips Alaska, introduced
Marianne Kah, Chief Economist, ConocoPhillips/Houston who
specialized in global economics and David Bramly with Charles
River Associates (CRA) International, a consulting firm to
ConocoPhillips which specializing in international oil and gas
fiscal issues.
Mr. Bowles acknowledged the challenges facing the Legislature in
its endeavor to revise the State's oil and gas fiscal policy.
The complexity of the issue has also been difficult for the
industry "to take on".
Mr. Bowles stated that after attending several Legislative
hearings on this issue, the company had gained a better
understanding of the information required of them to answer
Legislators questions and to provide further insight on the
issue. Therefore, today's presentation would concentrate on how
ConocoPhillips conducted its business and made its investment
decisions. The intent would be for these "tools" to assist
Legislators in the crafting of this petroleum production tax
(PPT).
Mr. Bowles advised against Legislators taking the philosophy of
increasing oil taxes to a point just short of "crippling the
industry and then backing off just a little bit from that
point". This would be likened to "not wanting to kill the golden
goose but we'll take him as close to death as possible and then
revive him". This presentation would include "a continuum on
this. That as the golden goose gets weaker, investment and
associated volumes respond accordingly".
Mr. Bowles also addressed the philosophical position that the
State's tax rate should increase due to the recent high profits
the oil industry has experienced by stating that the oil
business is "a very very capital intensive business. During good
times, we collect money and we have it ready to reinvest during
bad times". Today's presentation would attest that the industry
continued to make significant investments in the State during
the good times.
Mr. Bowles addressed the question of what would be the
appropriate percentage split of revenues, or "take", between the
State, the federal government, and the industry. The notion of
splitting the take into thirds "really has no basis in any type
of international competitive market". This presentation would
provide further insight to "how Alaska could be considered and
looked at with respect to world markets". Such information could
be utilized in the development of "a proper" tax structure.
9:11:32 AM
SB 305 (CS) Testimony
ConocoPhillips Alaska
April 5, 2006
[Note: The pages in this document are not numbered. For
reference purposes, the Senate Finance Committee Secretary made
a notation on each page of the corresponding timestamp in which
that page was addressed in the hearing. General descriptive
information of each page is provided in the body of these
minutes when feasible. A copy of the handout can be obtained by
contacting the Legislative Research Library at (907)465-3808.]
9:11:18 AM
[Note: The PPT bill introduced by Governor Frank Murkowski is SB
305. The version of the PPT bill being considered in the House
of Representatives is CSHB 488(RES). The PPT bill being
considered in the Senate is CSSB 305(RES). The House bill is
referred to as CSHB 488 and the Senate bill is referred to as
CSSB 305 in these minutes.]
Mr. Bowles referred the Committee to the "Projected Production
Tax Revenues" graph in the presentation [copy on file]. The
vertical scale represented "State Take (nominal 20-year sum)" in
billions of dollars. The horizontal scale depicted the revenues
the State would receive under the current production tax regime,
the Economic Limit Factor (ELF) as compared to the revenues
anticipated from SB 305, CSSB 305 and CSHB 488, as affected by a
$40 and $60 Alaska North Slope (ANS) prices per barrel of oil.
Mr. Bowles explained that at $40 per barrel, ELF would generate
approximately one billion dollars annually or a 20 year total of
approximately $20 billion. SB 305 would essentially double the
taxes currently paid to the State by the industry. While
acceptance of this increase was difficult for the industry, it
was made easier by the fact that the industry recognized, as did
the Legislature, that "it was time to change" the ELF system. As
a result, industry was "willing to support" the provisions in SB
305.
Mr. Bowles continued that at $60 per barrel, CSHB 488 would
"effectively triple" the tax rate under ELF. CSSB 305 could, at
current oil prices, quadruple the "total State Take in dollars
from industry". Today's testimony would contend "that taking
that amount of dollars from industry has to have some affect on
our capacity to reinvest".
9:13:24 AM
Prudhoe Gross Capital Spend vs Severance Tax Rate
Mr. Bowles stated that this graph would depict the "Prudhoe Bay
gross capital dollars spend over a five year period" from 2001
through 2006 as affected by ELF and the proposed severance tax
rates. Even though there has been some production decline, the
severance tax take percentage depicted by the blue line on the
graph indicated that during this time period had remained fairly
steady, ranging from ten to 12 percent. The increase reflected
in 2006 indicated "the aggregation that occurred last year when
the satellite fields were aggregated at Prudhoe Bay". The red
line on the graph would indicate that ConocoPhillips had
invested approximately $400 million dollars annually during this
timeframe. Separate testimony had indicated that the overall
annual industry investment on the North Slope was approximately
one to 1.5 billion dollars. Investment in Prudhoe Bay would
account for approximately one third of the total industry North
Slope capital investment. Even with rising oil prices, this
investment had been steady.
[NOTE: The labels of the graph lines on this chart had been
inadvertently reversed. See Time Stamp 10:25:13 AM for further
clarification].
9:15:02 AM
Kuparuk Gross Capital Spend vs. Severance Tax Rate
Mr. Bowles reviewed the industry's capital investment at the
Kuparuk field during 2001 and 2006 as compared to that field's
Severance Tax rate. The severance tax rate, depicted by the red
line, showed the declining severance tax rate under the
provisions of ELF. In 2001 the tax rate was approximately six
percent, and in 2006 the rate was approximately zero. When
comparing capital investments in Kuparuk to those in Prudhoe
Bay, the record would indicate that as the tax rate decreased,
investment increased. The size of the 2006 investment in Kuparuk
was approximately equal to the investment at Prudhoe Bay, even
though the Kuparuk field was approximately "2.5 times smaller in
production capacity". The conclusion was that the activity
occurring in Kuparuk was directly driven by the severance tax
structure.
[NOTE: The labels of the graph lines on this chart were
inadvertently reversed. See Time Stamp 10:25:13 AM for further
clarification].
Mr. Bowles surmised that CSSB 305 "probably puts that effective
severance tax rate anywhere between 16 and 22 percent … going
forward". Consideration should be given to how a tax rate of 16
to 22 percent might affect a field that had been experiencing
essentially a zero percent tax rate. "One would have to assume
that there's going to be a direct correlation to what we see in
that investment…"
9:16:57 AM
Senator Hoffman asked whether the numbers being presented were
limited to ConocoPhillips' activity in these fields.
Mr. Bowles clarified that the capital investments being
discussed "have been grossed up to reflect total field dollars
spent".
Senator Hoffman understood therefore that the information
reflected the total investment made by the major oil producers
operating on the North Slope.
Mr. Bowles affirmed. The Prudhoe Bay and Kuparuk field
investments would reflect total gross dollars spent. The
investments made at these two fields would amount to $800
million or approximately two-thirds of the investments occurring
today. This trend would be expected to continue in the near to
mid term future.
9:17:46 AM
Senator Bunde asked regarding ConocoPhillips' calculations that
the PPT would result in a severance tax rate of approximately 16
to 22 percent, as he understood the net tax under SB 305's 20
percent tax and 20 percent credit (20/20) PPT proposal would be
approximately nine percent and approximately 12 percent under
the 25/20 tax proposal in CSSB 305. Thus, his question was
whether this calculation methodology matched that utilized by
ConocoPhillips.
Mr. Bowles advised that the numbers could not be directly
compared. The methodology utilized by ConocoPhillips indicated
that the provisions of SB 305 would result in an approximate 15
percent severance tax. The House and Senate committee
substitutes would increase the tax beyond that.
Senator Bunde asked whether the 15 percent tax rate would be "a
net tax after credits".
Mr. Bowles, affirming it would be, explained that the effort
undertaken in the North Slope and Prudhoe Bay graphs "was to
convert this into an apple to apple comparison" by presenting
the numbers in terms of the present ELF tax system "which is
really just a tax on gross revenues". The 16 to 22 percent tax
rate estimation would be the result of the numbers under the
provisions of SB 305 being adjusted to "an equivalent percent of
gross revenue.
9:19:20 AM
Senator Stedman understood that the numbers in the PPT bill
would "flux" as the bill developed; however, according to State
calculations, a 15 percent severance tax under the 20/20
provisions of SB 305 would require a per barrel price of
approximately $80; a $50 per barrel oil price would result in an
approximate 12 percent severance tax rate. Tax rates would
fluctuate as oil prices increased and decreased.
9:20:09 AM
Senator Stedman recalled that, in terms of industry aggregate
numbers as opposed to individual company's numbers, the 2005 net
to producers, at an average per barrel oil price of $43, was
estimated to be approximately $4.7 billion. This was a
"historically high" amount. Recent estimates, based on average
oil price of $58.70 per barrel, would be that producers would
net approximately $6.5 billion in 2006.
Senator Stedman asked whether "large net income gains" might
influence the industry's capital decisions. In other words,
would industry opt to make capital investments rather than to
pay the federal government a significant amount of money. This
issue has not been addressed.
9:21:20 AM
Mr. Bowles responded that ConocoPhillips, with "one of the most
aggressive capital reinvestment programs" of any of the major
producers, was dedicated to that effort and was undertaking
numerous "significant projects" worldwide. The majority of
ConocoPhillips' "allocation of profits now goes back into
reinvestment, and to … established dividends", and retiring
debt, which at the end of 2005, amounted to approximately $13
billion.
Mr. Bowles communicated that "during bad times we take on more
debt" and during "good times", the effort was to reduce that
debt. The goal was to keep the company "steady" through both
good and bad times.
9:22:15 AM
Senator Stedman declared that efforts must be made to further
clarify the information, as research conducted by Econ One
Research, Inc., the economic research and consulting firm hired
by the Legislature, indicated that "the costs statewide" were
approximately $2.4 billion in 2005 and $2.3 billion in 2006.
Econ One must assist in clarifying whether these capital
investments were being compared in "an apple to apple"
scenarios.
Mr. Bowles concluded his remarks.
9:23:02 AM
CRA International
Review of Alaskan Fiscal Proposals
April 5, 2006
DAVID BRAMLEY, Vice President, Charles River Associates (CRA)
International, consultant firm to ConocoPhillips, explained that
CRA was "a global firm specializing in business consultancy and
economics". It served as oil and gas consultants to private and
national companies as well as governments. He experience
included working in the exploration and production (E&P)
division of Shell International and as a petroleum economist,
business planner and E&P consultant to oil companies and
governments in more than 30 countries. "Understanding the
applications of E&P fiscal systems and their business
implications is fundamental" to his job.
Page 1
Overview of CRA Approach
Will the proposed changes in Alaska's fiscal system support
new investment?
· Comparable group of mature OECD producers
· Economic potential
* Maturity/Prospectivity
* Cost base
· Fiscal Terms: Total Government Take
Mr. Bramley communicated that CRA had been retained by
ConocoPhillips to analyze the State's PPT proposals. The
analysis included comparing the PPT to "the fiscal environment
of other" mature and significant oil and gas producing
Organization for Economic Cooperation and Development regions
(OECD). He acknowledged the "difficult tradeoff" the State was
undertaking in deciding "between balancing the imperatively
short-term revenues with those of incentivizing investment to
arrest future production decline".
Mr. Bramley assured the Committee that CRA "did not approach"
this fiscal analysis with the viewpoint "that lower taxes are an
inherently good thing". Instead, "a comparable group of
international of oil and gas areas", the OECDs, were identified
and their fiscal systems compared "in the context of their
underlying economic potential and current levels of investment.
Through these comparisons we've sought to illustrate how well
Alaska's existing fiscal system is aligned to the economic
realities of the region and to infer what would be the
consequences for investment of the proposed changes." CRA drew
upon its experience "to generate working assumptions that we
believe reflect the techno-economic realities of each of the
comparison areas and applied methodologies". This would assist
in projecting how investors "will assess the impact of fiscal
terms in their investment decision making".
Mr. Bramley identified the question CRA strove to answer as
being whether "the proposed changes to Alaska's fiscal system
support new investment". The majority of the effort to answer
this question was based on comparing the State's existing ELF
tax system to the terms of SB 305, CSHB 488 and CSSB 305. He
would identify areas in which provisions in CSSB 305 would
affect the analyses.
Mr. Bramley stated that the answer to the primary question was
largely based on how the fiscal changes would affect investor
decision making. Both large and small oil and gas industry
investors operating in Alaska make their capital allocations
decisions "in the context of a larger portfolio of choices about
where to invest". There was "a huge range of competing options
in different parts of the world and different parts of the oil
and gas value chain". Like other sectors of today's economy,
capital mobility levels in the oil and gas business "are very
high".
Mr. Bramley declared that the OECD producers utilized in this
comparison were appropriate. While these producers were
comparable they were also different. "The underlying economic
potential of each of them" was presented in terms of "relative
maturity and remaining prospectivity on the cost base for
accessing available opportunities in each area". Another
comparison utilized was that of "the overall Total Government
Take of the net cash flow from investing in a typical new
opportunity in each area". This analysis was the "most
fundamental" influence in the effort to attract investors. All
applicable taxes including State and federal taxes were
included. The end result of all of these factors provided "an
effective high level view of the impact on investment of the
current and proposed Alaska fiscal term".
9:28:09 AM
Mr. Bramley stated that the approach taken by CRA was different
from other analyses in several fundamental respects. Further
information on these differences and how they affected the
conclusions of this report would be identified during the
presentation.
Page 2
Comparing Alaska's fiscal proposals to other mature OECD
producing areas is the basis for a realistic appraisal of
their impact on investment
OECD Oil & Gas Common Investment
Peer Group Characteristics
Alaska Similar strategic roles in
Australia NW Shelf overall investment portfolios
Canada Oil Sands *Large, established oil
Norway and gas producers
UK North Sea *Similar political and
US GoM Deep Water business risks
US GoM Shallow Water High level of comparability
*Remaining potential and
Costs are comparable
from public data
*Similar fiscal
structures
Investor Capital Allocation Decisions
Mr. Bramley stated that in order to make "meaningful comparisons
of investment attractiveness of the whole of the diverse range
of options available to investors" was complicated by different
corporate business strategies and different levels of risk and
rewards attached to those opportunities. Instead of
generalizing, the decision was made to focus on the comparisons
and the E&D activities of a select group of "developed world
economies". The investments made by this OECD group tended to
have similar strategic roles in overall investment portfolios;
they could "substitute for each other in terms of investor
decisions" as they were all "large oil and gas provinces of
global significant" with long production histories, existing
infrastructure; stable commercial regulatory mechanisms, and had
significant remaining reserves despite their maturity level.
They each had "free competitive access" and were absent of
barriers to capital investment. They also had similar levels of
political, legal and commercial risks. Overall they were a group
of investments with similar ranges of risk and reward.
Mr. Bramley also identified another commonality as being that
"one could readily distinguish and characterize investment
opportunities" in each area because they had similar fiscal
structure: a royalty tax structure as opposed to production
sharing. In addition, they tended to have "the tax ring fence
drawn at the corporate level". In conclusion, the OECD grouping
was "a good base" for CRA's analysis.
Mr. Bramley stated that had a different subset of opportunities
such as the "higher prospectively regions" of Angola and former
Soviet Union regions been included in the comparison, "the
results would have been fundamentally different". The comparison
would have been more complex and would have spanned a wider
range of risk and reward.
9:31:08 AM
Page 3
Alaska's production declined by 6% between 2000 and 2004:
in the middle of the group
Total Hydrocarbon Production Change 2000-2004
Region 2004 Production Growth/decline
(mboe/day) since 2000
US GoM SW 738 -27%
Australia NWS 403 -27%
UK 2,144 -19%
Alaska 946 - 6%
Norway 3,180 8%
US GoM DW 1,037 26%
Canada Oil Sands 997 64%
Norway's production dropped by 10% between 2004 and 2005,
the loss almost entirely through decline in oil production.
Source: CRA Analysis of public sources of production
history in each area
Mr. Bramley communicated that due to the extraction nature of
the petroleum business, the total economic potential of an area
would be a function of the types of its reserves "and the
technical and operational costs required to bring the resource
to market. A field's maturity should also be considered in
regards "to its remaining prospectivity since the best and most
economic hydrocarbon resources are typically discovered and
developed early in a region's life". Following that there would
be "a natural pattern of diminishing returns throughout the
remainder" of the area's life cycle. Thus, the level of
"maturity and remaining prospectivity of Alaska's fields
relative to other OECD regions would be an important factor in
defining the context for fiscal comparisons".
Mr. Bramley specified that the Alaska National Wildlife Refuge
(ANWR) was purposefully excluded from the comparison scenario.
In addition, the "currently uneconomic" heavy oil resources in
the State would be addressed separately in the presentation.
Mr. Bramley concluded that the "overall oil and gas production
from an area tends to rise to a peak" and then experience a long
and steady decline. The United Kingdom (UK) was the exception to
this characteristic. The information presented on page 3 was the
total rate of oil and gas decline or increase experienced by the
identified areas between 2000 and 2004; Alaska's production
declined by six percent during that timeframe. The State
experienced a similar six percent decline from 1980 to 2000. A
steeper decline rate was projected over the long term.
Page 4
Alaska has 44% of its known conventional oil and gas
reserves remaining
Total Hydrocarbons Produced/Remaining
[This bar depicts the amount of oil and gas produced to
date and the estimated amount of oil and gas reserves
remaining.]
Mr. Bramley advised that the State's remaining "oil and gas
reserves and their size relative to past production from an area
are another fundamental measure of maturity". The bar charts
presented on this page depicted produced oil and gas volumes to
date in green coloring and remaining reserves in blue. He noted
however, that "definitive reserve figures" were difficult to
determine. The numbers in red above Alaska's and other OECD
regions depicted the percent of reserve potential relative to
past production. The region with the lowest remaining reserve
levels was the UK. Alaska with 44 percent of its reserves
remaining was the second lowest of the comparison group.
9:33:59 AM
Page 5
Alaska and the UK are the only regions within the OECD
group to show a decline in proven oil and gas reserves over
the last decade
Change in Total Proved Reserves (1994-2004)
[This bar chart is a comparison of Alaska to other OECD
regions based on the area's ability to replace used
reserves with proven reserves.]
Mr. Bramley stated that another measure to be considered would
be an areas' renewal ability. In other words, how successful an
area might be in "replacing year by year production with proved
petroleum reserves". Besides the UK which is just slightly below
replacement production, only Alaska "failed to replace
production on a proved reserve basis over the last ten years".
9:34:30 AM
Page 6
Alaska has had only eight new fields start production since
2001 and the average field size was the smallest of the
group
Average New Field Size vs. Number of Starts
[This graph depicts the number of new fields and average
field size for Alaska and other OECD regions between the
years 2001 and 2005.]
Mr. Bramley cited the number of new field developments in an
area as another measure used to depict "an area's potential to
add to its producing base and to arrest long term production
decline". Alaska had "the lowest number of new producing fields
and the smallest average size" in the comparison group.
9:35:02 AM
Page 7
Alaska has the lowest exploration (wildcat) activity and
success rate in the OECD comparison group
Exploration Activity (1995-2004)
[This bar graph compares the number of wells explored
between 1995 and 1999 to those explored between 2000 and
2004 in OECD regions. The graph also indicates the number
of successful exploration efforts an area experienced from
2000 and 2004.]
Mr. Bramley explained that this information depicted the number
of exploration wells drilled in areas over the past ten years.
The green portion of each area's bar indicated the number of
wells drilled between 1995 and 1999 as compared to the activity
for that area, as reflected by the blue portion of the bar
chart, for the years 2000 to 2004. The numbers in red above an
area's bar chart would reflect the percent of its exploration
wells during the ten year period which held oil and gas in
commercial quantities. Alaska lagged behind the other areas
"both in terms of the number of exploration wells drilled and
the number of those wells which were commercially successful".
9:35:48 AM
Page 8
Likely new developments in Alaska are relatively small and
high cost
Typical New Development Size and Cost
[This graph compares the cost of new field developments in
Alaska to other OECD regions in terms of estimated capital
and operating expenses. NOTE: Alaska's total costs include
an allowance for the incremental effects of TAPS
transportation and Jones Act shipping requirement costs.]
Mr. Bramley stated that CRA developed profiles of a "typical
field" in Alaska and other OECD regions based on "recent
development history and an analysis of the available set of
forthcoming opportunities". This information helped in
"characterizing an area's economic potential and [was] a good
basis for our later calculations of Government Take and economic
terms".
Mr. Bramley explained that the bars on the chart depicted the
typical size of a field in an area. The numbers in red at the
end of each bar reflected the total "capital and operating costs
of a barrel of oil equivalent to bring that oil and gas to
market". The Alaska, the UK, and the United States Gulf of
Mexico Shallow Water fields were the smallest fields each with
an average of 50 million barrels of oil equivalency [BOE]. Those
three areas' costs were also the highest at $15, $11.50 and
$9.50 per BOE, respectfully, for new developments.
9:36:53 AM
Page 9
Alaska emerges on a variety of measures as a relatively
mature and high cost petroleum area
[This document provides a percentage comparison of
production trends, reserves produced, proved reserves
replacements, new field starts/field size, exploration
wells, exploration success rates, and new field technical
costs for Alaska and other OCED regions. The information is
also color coded to indicate high, mid-range, and low
remaining prospectivity levels.]
Mr. Bramley stated that this was a summary of the information
presented on pages 3 through 8. The overall trends were depicted
in colors: "red indicates low prospectivity levels and
conversely high maturity and high unit costs", green signified
high prospectivity levels and low costs, and yellow signified
mid-range prospectivity levels. Alaska was "predominately in the
red category". This should not be interpreted as Alaska having
"little remaining economic" and resource potential, for it and
the other OECD areas do. However, the meaning of this
information "in relative terms" was that Alaska would rank "low
in this group" for its "attractiveness to investment". The
maturity analysis also raised concerns about the impact of the
State's existing fiscal terms as this information would indicate
that Alaska's current tax regime was not very competitive for
new investment. Alaska ranked lowest in the OECD grouping "on
measures closely related to production replacement activity; in
other words, exploration drilling numbers and new field starts,
even before looking at direct fiscal comparisons. That doesn't
suggest a highly competitive climate for new investment."
9:38:35 AM
Page 10
The basic PPT 20/20 proposal gives Alaska the second
highest level of total government take within the group
Total Government Take versus Total Technical Costs
[This graph illustrates how Alaska, were the SB 305 20/20
PPT proposal adopted, would be positioned in comparison to
other OECD regions in terms of Total Government Take verses
operating and capital expenses costs.]
Mr. Bramley stated this chart provided "direct" comparisons of
Total Government Take throughout a producing field's life.
"Calculating this involves modeling the way in which the
relevant fiscal regime divides the available cash flow from a
single additional new field between the government and the
company investor." A $35 per barrel "real terms" price was used
in this analysis "because we believe that this is close to the
central planning assumption that most investors are currently
using for the decision making. Investors will always look at the
implication of higher and lower prices for their decisions as
well. We've also modeled those and the conclusions we draw from
that for Alaska competitiveness are rather similar to or
stronger than the one's" depicted on this chart. Total
Government Take, as represented "on the vertical axis of this
chart … is a good measure of the share of the total available
economic value of the field that's captured by a fiscal system.
It takes full account of the affects of tax rate, tax credits,
and all of the mechanisms inherent in each system. In
calculating this figure for a typical field, you'll get
something close to a like for like comparison of the kind that
will emerge in investor portfolios when they review
opportunities across this group."
Mr. Bramley stated the chart depicted the "total government take
for each region on the vertical and on the horizontal the unit
technical costs for our typical representative field for each
area."
9:40:36 AM
Mr. Bramley noted that the State's total government take under
ELF "is third highest" in the group. Under the provisions of SB
305, its overall take would increase eight percent. This
"significant change" would place the State "second highest in
the group". CSSB 305 with its 25/20 tax structure and
Progressivity feature would, at a $35 barrel price, increase
government take an additional three percent for a total
Government Take of 64 percent. The level of take would increase
as barrel prices increased.
Mr. Bramley pointed out that Alaska's higher cost base was also
illustrated on this graph. It might be expected that the overall
relationship between "technical costs and tax take would be some
kind of inverse correlation. With higher costs corresponding to
lower levels of government take. All of the things being equal
that would probably be the case, but in reality a more complex
relationship exists. Prospectivity, field size, and growth
potential also play a strong role, and tax take also depends on
choices by the government on the tradeoff between short term
revenue and investment incentivization."
9:42:07 AM
Page 11
High costs and lack of prospectivity compound the impact of
Alaska's high overall government take
Total Government Take versus Total Technical Costs
[This chart illustrates the government take for various tax
regimes, including Alaska's current ELF and the proposed SB
305 tax structure, as influenced by a field's maturity
level and field costs.]
Mr. Bramley stated that this graph expanded the information on
the graph on page 10 to include a field's maturity level.
Alaska's current "positioning is "problematic" as it is a mature
region "with a relatively high unit cost base but with a
relatively high government take. The fact that levels of
reinvestment in new exploration and development, even under the
current system are also fairly low, adds to the concern around
the potential impact of the new proposals."
Mr. Bramley pointed out that under the tax rates and credits
proposed in the PPT legislation, the total government take for a
new field "developed entirely by a group of new investors" would
be similar to the take currently collected under ELF.
9:43:41 AM
Senator Bunde remarked that the State's long term forecast
predicted a $40 barrel price. Other economists predicted higher
prices. Thus, he asked how higher prices would affect this
modeling.
9:44:00 AM
Mr. Bramley replied that the rankings would not change. However,
under ELF and SB 305, there would be "some convergence" between
the Norwegian and Alaskan rates. Were prices to decrease, Alaska
would be number one is government take due to the regressive
nature of the State's royalty provisions at lower oil prices.
9:44:56 AM
Mr. Bramley furthered his remarks about the regressive and
progressive elements of the State's current and proposed SB 305
tax structures. The State's system was "regressive in a nature
not duplicated in other OECD tax regimes", as its level of
government take increased at lower prices and decreased at
higher prices. "This in itself is not helpful in supporting
investment decision making." The Progressivity components of the
committee substitutes being furthered by both the House and the
Senate would "produce a pattern of upside progressiveness and
downside regressiveness, which is very very unusual," and, in
his experience, "unique".
Mr. Bramley, reiterating that Alaska's total government take was
only surpassed by that of Norway, reminded the Committee that
Norway had "significantly more" economic potential than Alaska.
The "exploration prospectiveness" of oil reserves off its coast
could result in it becoming a major new oil and gas region.
Norway's three largest oil and gas companies had substantial
government ownership, thus there was "strategic commitment" to
developing those offshore resources. Consequently attracting
"international competitiveness is less of a central issue" to
the Norwegian government than it would be for other regions. Of
utmost significance was the fact that Norway had followed "a
policy of measured development towards its oil and gas
resources". As a result, "strategic control and maximization of
government take tends to dominate over stimulation of high
levels of new investment."
9:47:23 AM
Co-Chair Green asked the level of private investment in Norway's
oil and gas industry.
Mr. Bramley estimated that 80 percent of the ownership interest
in Norway's three largest oil and gas businesses was held by
private entities.
9:47:49 AM
Senator Stedman was confused by Mr. Bramley's remarks that
Alaska's current system was regressive in nature and that the
PPT with its Progressivity element would introduce progressive
taxes. This was contrary to the Department of Revenue's
projections which indicated that the State's total government
take under PPT, after the proposed severance tax, property tax,
corporate income tax, and the federal income tax were factored
in, would remain "fairly flat, with a very slight regressive
nature to it". Therefore, he requested further definition of the
term "progressive nature"; specifically in regards "to what
level and then at what magnitude it would begin to affect their
economic models".
9:49:08 AM
Mr. Bramley stated that the use of the terms regressive and
progressive in CRA's modeling was used "in the context of the
relationship of government take to overall economic value". The
term progressive would be used to describe a scenario in which
"the overall economic value of the underlying resource goes up
and the fiscal system produces a higher government take at that
higher level of economic potential". The term regressive would
describe a situation in which government take decreased at
higher prices. This term would also refer to a situation in
which government take increased as prices decreased.
Mr. Bramley continued that CRA's "analysis is not fundamentally
different directionally from the ones I've seen from the
Administration" and other consultant's analyses.
9:49:59 AM
Mr. Bramley stated that "the net affect" of the State's
royalties and other "fundamentally regressive" tax elements and
the progressive element included in CSSB 305 would, in effect,
create a "u" shape: at low prices of $20 per barrel, for
example, the State's government take would increase to
approximately 80 percent under the PPT. The "point of
inflection" under the provisions of CSSB 305 would be
approximately $40 per barrel.
Mr. Bramley addressed investor behavior. They would first
identify a range of prices around a current price in order to
project what might happen in the future. The prospects at both
the progressive end and the regressive end of that spectrum
would be an important consideration; therefore the two scenarios
"would be aggregated together" to provide the "bottom line … or
expected value of an investment".
9:51:55 AM
Mr. Bramley pointed out that the regressive and progressive
elements contained in the proposed PPT "is in itself,
fundamentally unhelpful. It's very very unusual and it creates
an additional pattern of uncertainty in decision making because
of its unusualness".
In response to a question from Senator Stedman, Mr. Bramley
affirmed that the OECD region in Australia being referenced in
the comparisons was on Australia's northwest shelf.
Senator Stedman asked regarding the tax structure utilized in
that region.
Mr. Bramley responded that its tax structure included a
corporate income tax and a special royalty tax referred to as
the petroleum resource rent tax. This tax structure was a "flat
tax" rather than a rate of return tax.
9:53:06 AM
Senator Stedman communicated that the oil and gas industry tax
system in Alaska had not, until recently, been compared to that
of Australia. At some point, he hoped CRA would provide its
perspective on the two oil fields being developed in northern
central Russia, which had been discussed in a separate
presentation by Daniel Johnston, the oil and gas consultant
hired by the Legislature. Senator Stedman was particularly
interested in CRA's viewpoint about "the suitability of those
[tax] regimes".
9:54:11 AM
Mr. Bramley reiterated that the OECD comparison group utilized
in this presentation by CRA were picked because they embodied "a
range of risks and rewards to investors" that were similar to
those found in Alaska. The two Russian fields were
"fundamentally different from the opportunities" in any of the
areas in the page 11 comparison as "they are much bigger". The
fact that CRA had "taken the view that investors will look at
economic potential in terms of prospectivity as a fundamental
part of their decision making" is one of the reasons that CRA's
analyses differed from others. CRA's position was that investors
would be willing "to accept higher levels of government take for
larger fields or lower costs or greater growth prospects … those
things would have a fundamental impact". Therefore, CRA did not
consider the two large Russian fields to "have the same economic
potential on which to make fiscal comparisons".
Senator Stedman communicated he would further this discussion
separately with Mr. Bramley, as he thought that the Russian
fields he was referring to differed from those Mr. Bramley had
in mind.
MARIANNE KAH, Chief Economist, ConocoPhillips agreed with Mr.
Bramley's remarks about the Russian fields provided the two
fields being discussed were located in Arctic Russia.
ConocoPhillips was considering developing a 750 million barrel
field in Arctic Russia, and, due to the immense size of that
field, the company would be willing to accept higher tax rates.
Alaska's field sizes were in the 30 to 50 million barrel range.
The tax rate must be "commensurate with the prospectivity".
9:56:53 AM
Page 12
Alaska's largest potential is in its producing fields,
heavy oil and gas resources: PPT 20/20 is a dis-incentive
to investment in these
Alaska's Resource Potential
Resource Type Comparable Incentivized by PPT
Size 20/20 proposal?
Producing Fields/ 2 - 5 bn boe Higher tax take is
a direct disincentive
Known Undeveloped
Resources:
Conventional Oil ~0.5 bn boe Only small and/or
new players have
some incentive
Known Undeveloped
Resources:
Conventional Gas 6 - 8 bn boe Higher tax take
is a direct
disincentive
Gas pipeline may
Transform
attractiveness
Known Undeveloped
Resources:
Heavy Oil 5 bn boe Higher tax may
cause
Serious delay to heavy oil development
Exploration) <1 bn bbl Only small and/or
Potential (YTF) oil potential? new players have
some incentive
Gas potential
may be higher
Mr. Bramley stated that the discussion about how the PPT would
impact future investment should consider where Alaska's future
resource potential might be located. The table on page 12 would
provide evidence that "Alaska is in a somewhat unusual position
of having the majority … of its future resource potential in the
form of known but undeveloped hydrocarbons". The known but
undeveloped oil, heavy oil, and gas resources were
"significantly larger than the resources likely to be available
through new exploration and through undeveloped conventional
oil. … The prospect of higher government take" as proposed under
the PPT would directly impact the development of these
resources. Reducing the level of government take on "new
entrants for their early developments" would not assist in
developing resources in "areas where the largest pots of
Alaska's potential actually lies".
Mr. Bramley stated that CRA's conclusion from its analysis
"about Alaska investment attractiveness, is that the new
proposals will inevitability reduce future investment in oil and
gas".
Mr. Bramley pointed out that even though the majority of CRA's
study pertained to SB 305, their conclusion was that the House
and Senate committee substitutes "with higher levels of
government tax take, would reduce that attractiveness even
further".
9:58:26 AM
Senator Bunde understood that ConocoPhillips had originally
agreed to the 20/20 percent proposal presented in SB 305. To
that point, he asked the reason the company had agreed to
something which contained numerous "disincentives" to future
investment.
Mr. Bowles communicated that the company has also pondered its
decision in that regard. "In the broader context though …. one
aspect of the 20/20 proposal" that was agreed upon by
ConocoPhillips, Exxon, and BP, was that it would lay "the
groundwork for proceeding to the next step with the gas
contract". A gas pipeline would serve to "bring large
investments in itself, but it will also spawn effectively a new
exploration and development activity on the Slope with respect
of exploring for both gas and oil combined". Thus, the
combination of the benefits derived from the growth in
investments, jobs and production volumes would outweigh "the
downsides" of the 20/20 proposal.
Senator Bunde understood therefore that ConocoPhillips felt that
a conventional gas pipeline would be attractive to investors.
Mr. Bowles concurred.
10:00:02 AM
Senator Dyson stated that in November 2006, the State's citizens
would be voting on whether to adopt a ballot initiative to
impose a gas reserves tax. While he thought it "would profoundly
affect the attractiveness of Alaska", he understood that its
affect on new resource exploration and development companies
would differ from that on existing lease holders. Thus, he asked
ConocoPhillips to comment on how the adoption of this ballot
measure would affect the company.
Mr. Bowles responded that the adoption of the gas reserve tax
initiative "would definitely" affect new players differently
than it would affect "the three that would be targeted … the
biggest signal though that would go out" by the adoption of that
initiative "would be the fact that we have a fiscal tax regime
that could change in such short notice through a ballot
process". Were it adopted, the industry could be subjected to an
annual billion dollar tax increase. While it might "only
directly affect three companies", it would communicate to
newcomers in the State's resource industry "that they could be
subject to some form of change of that magnitude once they had
operations on the ground".
Senator Dyson asked how the adoption of the measure would affect
existing lease holders in the Prudhoe Bay field; specifically
"the investment propensity" of those who have "a big part of the
gas cap".
Mr. Bowles communicated that a key element of the company's
testimony today was how taking "dollars away from the industry"
could affect investment. The adoption of the PPT could levy an
annual one to two billion dollar tax increase on the industry.
This would affect future investment as it would negatively
impact the amount of capital available for investment. The
adoption of the gas reserve tax could levy an additional tax
which would further reduce the amount available to invest. It
"would be another nail in the investment coffin".
Senator Dyson communicated that people in support of the gas
reserve tax believe "it would be an incentive to get that gas to
market". He asked Mr. Bowles' position on that line of thought.
Mr. Bowles responded that ConocoPhillips stated that "even if we
started welding pipe the day before the ballot initiative came
up, we would still be subject to that billion dollar a year tax,
effectively until gas sales started possibly ten years later". A
gas reserves tax could not be viewed as "an incentive to
starting actual work on the pipeline".
10:03:37 AM
Senator Stedman identified this as being an area to which little
discussion had occurred. Numerous competitive resource basins
around the world included "relinquishment provisions in a lot of
their leases". As a result, industry must develop a field within
a particular timeframe or lose those leases. A lack of similar
provisions in Alaska leases could place the State at "a
competitive disadvantage for the flow of capital" because
capital would be utilized in areas with development time limits.
Rather than suggesting that similar provisions be included in
Alaska law, he wished to point out that such action in other
resource regions would influence "the flow of capital" on a
worldwide basis. He asked the testifiers to address how others'
relinquishment provisions might affect on Alaska.
10:04:53 AM
Mr. Bramley acknowledged that the OECD regions included in the
comparisons do include relinquishment provisions in their
leases; however, "they're generally not as aggressive in these
areas as in areas which have production sharing type contract
arrangements." He communicated that rather than being a "driver"
of where investments occur relinquishment provisions would be a
consideration in areas "at the margin". In other words, a
competitive area "would attract capital".
10:05:41 AM
In response to a question from Co-Chair Wilken, Mr. Bramley
affirmed that oil and gas reserves in ANWR and the National
Petroleum Reserve-Alaska (NPR-A) were purposefully excluded from
consideration in this presentation.
10:06:15 AM
Senator Dyson asked whether CRA had considered whether the
investments "made on planning, permitting, and construction of
the gas pipeline will be subject to credits or deductions" under
the provisions of any of the PPT bills being discussed.
Mr. Bramley responded that this issue was not a consideration in
this analysis. He agreed with Mr. Bowles "that it is self
evident that it would transform attractiveness for investment
simply because of the affect on incremental economic potential
of opportunities here in Alaska". This presentation focused "on
the affect of the current PPT proposals" under current
conditions.
10:07:51 AM
Senator Dyson asked whether any of the PPT bills would allow
"the gas pipeline development costs to be a deduction or a
credit on the PPT taxes".
Co-Chair Green assumed the bills were "silent" on that issue.
Senator Dyson identified this as an important consideration
going forward; as such activities were "interwoven
intrinsically". Further information in this regard could be
sought from the Administration.
10:09:02 AM
Co-Chair Green communicated that this question could be added to
the set of questions being developed by the Committee.
10:09:27 AM
Page 13
If Alaska wishes the new legislation to stimulate
investment, a new system that reduces total tax take would
be required
Total Government Take versus Total Technical Costs
[This chart compared remaining prospectivity levels for
incremental fields of Alaska under the existing ELF and
under a 20/20 PPT as compared to the remaining
prospectivity levels of other OCED regions at a $35 per
barrel price.]
Mr. Bramley expressed that CRA was not in a position to
recommend "the appropriate level of government take" in Alaska;
however, the information garnered from this study "led to an
inescapable conclusion that the balance of the current proposals
is slanted more towards short term revenue over stimulation of
new investment to stem future production decline".
Mr. Bramley stressed that in order "to have reached a different
conclusion … a system that yielded total Government Take lower
than the existing ELF" tax structure would be required. While he
was uncomfortable sharing this conclusion, he hoped that the
evidence presented supported it.
10:10:14 AM
Senator Bunde puzzled about having to develop a taxation
structure "less than" the existing ELF tax structure, as ELF was
expected to generate zero tax revenue in the future.
10:10:38 AM
Mr. Bramley, hesitating to suggest a taxation level, voiced that
the conclusion reached by CRA "is that the price the existing"
ELF tax structure "sets on Alaska investments is already high".
The price that would be required "to stimulate more investment"
must be lower than that under ELF.
Senator Bunde reiterated that in the foreseeable future, the tax
revenue generated by ELF would be zero. While a zero tax would
encourage investment, "it would be an abrogation of our
Constitutional requirement".
Mr. Bramley acknowledged. CRA's "analysis of the investment is
analyzing only part of the economic equation, and it's certainly
not analyzing any of the political equation." The intent of this
study was "to provide an analysis of Alaska's positioning on a
like for like basis". CRA's conclusions were based on that
analysis.
10:11:52 AM
Senator Stedman remarked that "unlike the socialist regimes"
which have oil and gas resources, Alaska does "not have the
ability to nationalize our relationship and/or relinquish
rights". Were that the case, the State could opt to re-bid
current leases and "the open market would set those rates".
However, "as a steward of the citizens' assets," determining the
proper tax structure is difficult, particularly in consideration
of recent years' global marketplace "adjustments and the
splitting relationships between the industry and the
governments". Other regimes have moved "toward more progressive
systems where the splits stay more constant". The consideration
of whether to lower the State's taxes should not ignore such
events. Numerous factors, including the control of and assess to
a basin, influence the movement of free capital in and out of
the North Slope. The process should be one of negotiation. As
Senator Bunde stated, "we are stewards of this one time asset;
this one time finite resource in the ground that citizens of
Alaska own". The elements contained in ELF and the proposed PPT
are "the mechanisms" through which the State could sell its
resources. The process would entail "a sharing relationship with
industry and the federal government".
Senator Stedman identified the PPT "trend" evolving from the
Senate and House as being a tax rate ranging between 20 and 25
percent with some Progressivity level. Projections are that the
government take under ELF would decline from the current 60
percent current to 52 percent over the next 15 years.
Senator Stedman concluded that "the buyer of the asset always
feels that he's paying too much and the seller of the asset
always thinks he's selling it" for too little.
Mr. Bowles deemed Senator Stedman's points to align with the
intent of ConocoPhillips' presentation. "The geopolitical
environment is one reason that we do believe strongly that the
OECD countries probably are the best comparison … as far as
competition out there for world wide capital". In response to
Senator Bunde's concern, he declared that "by no means are we
suggesting that taxes should be zero". One of the notable
objectives of this discussion would be the realization "that it
is not an elastic system; taxes do have a direct impact on
investment and that at the end of the day it is your
responsibility for finding that right balance". ConocoPhillips'
effort revolved around trying "to communicate how we see the
cause and effect of tax against investment in volume
development".
10:16:03 AM
Page 14
Why is CRA more pessimistic about investment than previous
testimony?
· Investors have choices, and more tax will drive some
capital away
-CRA 'portfolio pricing model' rather than 'threshold
model'
· Tax credits don't offset the impact of higher tax
rates
-CRAs 'typical Alaskan field' shows clearly the
economic penalty of PPT 20/20
· Fiscal structure biased towards tax credits likely to
be a dis-incentive for most investors
- Tax credit bias erodes upside
- High price environment means scale, efficient use of
scarce human resource, is key factor
· Alaska's investment attractiveness low for current ELF
levels of government take
-PPT 20/20 is already a significant dis-incentive
-Higher rates and/or progressivity will compound the
impact on investment
Mr. Bramley reviewed the reasons CRA's conclusions differed from
others. As with any increase in the price of something, some
investors might accept the tax increase while others might not.
Capital would migrate away from the State were the tax level to
increase. Total government take would be "the primary fiscal
driver" in influencing investor behavior. The effects of tax
credits, deductibility of capital and other effects of the
change were considered in the study. The determination was that
tax credits would benefit investors but that benefit "is
strongly outweighed by the proposed higher tax rates". Investors
"would not view the tax credits and deductibility in isolation
from those higher rates".
Mr. Bramley declared that fiscal structures were a complex
issue. The question would be which tax structure an investor
would prefer when considering any "two tax structures providing
the same government take" where one is more dependent on tax
credits than the other. Not all investors would make the same
decision. CRA believed "that the majority of investors would
prefer the system that's more generous in its tax rate and less
generous in its tax credits", as tax credits would "erode upside
and secure downside". The "main constraint that companies have
is not their capital but their qualified people. Companies are
pushed toward scale and larger projects … and a generous tax
rate is more effective at giving that than tax credits are."
Mr. Bramley stated that the fundamental consideration of the
State's "investment attractiveness is the context of its
underlying economic potential". The conclusion of the effort to
"rank Alaska's fiscal attractiveness within the OECD group" was
that "the price is already high".
10:19:35 AM
Mr. Bramley stated that the important question left unanswered
was "So what?" should the State worry that investment in the
State would reduce were the PPT enacted. The answer to that
question was uncertain. While the State would be responsible for
balancing revenue, investment and growth, future activity was
difficult to predict.
10:20:21 AM
Page 15
So what might the future look like? Some illustrative
numbers
Tax Revenues to Alaska
[This graph compared tax revenues Alaska would receive
under ELF system to the proposed 20/20 PPT with no
production change as well as to the proposed 20/20 PPT with
reduced production from the year 2007 through 2026.]
Mr. Bramley stated that, while no one could "confidently"
predict whether higher taxes would reduce investment "and how
that would in turn effect production decline", some possible
outcomes were illustrated on this page.
Mr. Bramley explained that the vertical axis represented the
total amount of taxes paid to the State. The horizontal axis
reflected the timeline 2007 through 2026. The lower graph line
indicated the projected tax revenue generated by ELF and the
upper graph line reflected revenue projections of SB 305. Both
of these revenue projections were based on a $35 per barrel oil
price and the "base forecast of production", which projected
that by the year 2014 production would decrease to approximately
690,000 barrels a day or an annual "decline rate" of
approximately three percent. This decline rate was more
optimistic than other forecasts.
Page 16
What could this mean for Alaska? Some illustrative numbers
Taxes: Gains Investment Jobs:
and Losses Reduced Lower Activity
2007-2011 +$700m 20% reduction Direct Loss
Means $2-3 bn 500-1000
lost over 10 years
2012-2016 -$700m $1bn lost from Indirect Loss
Alaska GDP? 1500-3000
Mr. Bramley stated that, as depicted on this graph, the PPT
would reduce investment and thereby cause production to decline
faster than in the base case forecast. In the short term the
State's revenue would increase; however over time the decrease
in production would reduce tax revenue. Ongoing investment would
decline by 20 percent as a result of the new taxes. Production
decline would be two percent per year more than in the base
forecast. The State would gain revenue until approximately 2012.
After that the production decline would lower tax revenues under
those generated by ELF.
Mr. Bramley attested that 500 to 1,000 industry jobs would be
directly lost due to the decline in investment "based on current
levels of employment and spending". Additional losses of up to
3,000 service industry jobs could transpire. Along with the 20
percent loss in capital spending, or $2 to $3 billion over a ten
year period, "there would be a significant affect on the State's
gross domestic products (GDP). A conservative estimate would be
for a drop of a minimal one billion dollars over the next ten
years.
Mr. Bramley stressed that a debate of these issues would be
beneficial as others might have a different view. He would be
surprised however were anyone to expect the overall level of
investment to remain steady or increase as a result of the
higher taxes.
Senator Hoffman asked how a $50 per barrel of oil price would
affect revenue assumptions.
Mr. Bramley would not predict how a $50 per barrel price would
affect the graph. However, "there is no reason to believe that
the underlying effect on investment and production decline would
be different". The relative positions would remain the same.
"The fact of a tradeoff between declining production and the
higher tax rates would be inescapable".
10:24:29 AM
Senator Bunde again questioned the reason a $35 per barrel price
was utilized in the calculation, as the long range forecast was
$40 a barrel.
Mr. Bramley expressed that CRA determined $35 to be in "the
center of the range that investors are considering". Some
investors might invest at a higher price and others might invest
at a lower price.
10:25:13 AM
Senator Olson concluded from the Resource Potential table
depicted on page 11 that a higher tax would "drive away"
investment capital. However, this was contrary to the
information presented in the Prudhoe Bay and Kuparuk "Gross
Capital Spend vs. Severance Tax Rate" charts discussed earlier
by Mr. Bowles. Those charts indicated that capital investment
was declining under ELF.
Mr. Bowles stated that the graph lines on the two aforementioned
graphs were incorrectly labeled. The correct scenario was that
the capital investment in both those fields had increased as
their ELF severance tax rate declined.
Senator Stedman pondered "the correlation between the escalating
oil prices" during the last two years "and the drive for more
capital expenditures". It seemed that at times of high prices,
the industry would attempt to "expand their production and
production capabilities to service that demand and capture those
higher sales". To that point, he asked how much of that effect
was reflected on the charts.
10:27:49 AM
Mr. Bowles responded that this element was one reason the
comparison between the activity in Prudhoe Bay and Kuparuk was
provided. The effect of increasing prices would have applied to
both fields; however, as reflected at the Kuparuk field, there
was "a very direct correlation to reduction in tax and an even
dramatic affect in investment increase". Senator Stedman was
correct that in the overall scenario, more investment in the
industry was going into oil and gas development around the
world. "That capital would flow to where the best returns are".
The Kuparuk chart provided evidence "that the tax structure has
been creating a very favorable investment scenario and dollars
are flowing to it as a result".
10:29:04 AM
Page 17
Increasing Alaska's oil and gas taxes will have a price
· We recognize the dilemma of balancing revenues and
investment
· Alaska is mature, but has undeveloped potential
o Low prospectivity and new field size
o High cost base
o BUT huge known resources, heavy oil especially
· Current fiscal proposals do not help competitiveness of
OECD peer group
· Loss of Competitiveness will mean less investment and lower
production.
Mr. Bramley acknowledged "the dilemma of balancing revenue,
investment, and growth". CRA "has focused on the investment side
of the equation". "Alaska is a mature province but one with an
enormous remaining potential. The challenges of accessing that
potential are also enormous, but because … the potential lies
largely in known resources rather than in exploration, a
competitive fiscal regime can provide effective support in
turning speculative resources into real tax paying production.
The current fiscal proposals do not help competitiveness verses
your international peer group, and will make investment in
Alaska less attractive than it is at the moment. Reduced
investment will mean fewer jobs and will in time result in lower
production and lower tax revenue. I belief that neither more
analysis nor the passage of time will change that conclusion."
Mr. Bramley concluded his presentation.
10:30:08 AM
Senator Stedman brought up the prospect of there being a gas
pipeline on the North Slope. He understood that the gasline
would work in conjunction with an oil line. To that point, he
asked whether an analysis had been conducted on where the
deflection point would be for the two lines. He also recalled
that 300,000 barrels of oil a day would be required to maintain
a viable oil line. Therefore, his question was whether the PPT
would result in a decline in oil which would jeopardize the oil
line's operation. Loss of the oil line would negate the gas
line's feasibility.
10:31:14 AM
Mr. Bowles qualified that a threat to the viability of the oil
pipeline should not be garnered from this testimony. What should
be derived from this discussion was that there was "clearly … a
direct cause and effect between taxes and investment in barrels
and whether or not the critical level on TAPS is 300,000 or some
other number that's yet to be worked out and optimized." The
overriding conclusion of this presentation should be that "it is
strictly a policy call" as to what the State should do to
balance "the income to the State from State resources against
the continual investment of dollars in the State". The impact on
short and long term tax revenues to Alaska which might result
from the implementation of the PPT, as presented on page 15 of
Mr. Bramley's presentation, were enlightening. He seconded Mr.
Bramley's suggestion that other consultants should be asked
"their view of what is the potential impact of the loss of
investment in volumes".
Senator Hoffman pointed out that ConocoPhillips was one of the
first companies to agree to the 20/20 tax structure proposed in
SB 305. However, ConocoPhillips' television advertising touting
"no new taxes or increased taxes" do not appear to reflect that
support.
10:33:40 AM
Mr. Bowles stated that the intent of the advertising was to
further the awareness of the correlation between taxes and
investments in the State. The company would support "going
forward with something that the industry can see as a balanced
tax structure; something that would allow not only a good strong
continual investment in the State but also the investment in the
gas line and what additional investment in jobs will come from
the gas line development". The company's advertising was
designed to place "investment in perspective of not only oil but
what comes out of it in the way of gas development".
Senator Hoffman communicated that that was not the message he
garnered from the television commercials.
10:34:39 AM
Mr. Bowles appreciated Senator Hoffman's and others feedback.
Such input would be considered as the Company continued its
effort "to develop a communication package" that would convey
"the correct message to Alaskans".
10:35:16 AM
Senator Olson noted that the commercials appeared to have been
filmed the previous summer. Were that the case, "the message was
already there even before" the Legislature had been aware of
"what the numbers were going to be" in the PPT proposal.
AT EASE 10:35:51 AM / 10:36:51 AM
Co-Chair Green informed the Committee that the plan would be for
the Committee to reconvene after the 11:00 AM Senate Floor
Session.
10:37:39 AM
MARIANNE KAH, Chief Economist, ConocoPhillips identified herself
as representing "the corporate planning function of
ConocoPhillips". Because she assisted the company's Board of
Directors in developing its investment strategy, she could
provide insight as to how the PPT tax being proposed might be
viewed by investors and how it might change their investment
behavior.
Ms. Kah stated that the primary focus of her remarks would be to
counter consultant reports which have implied that the State's
tax rate could be changed without having any impact on
investment. She reviewed her written remarks (copy on file) as
follows.
[NOTE: Ms. Kah's testimony was accompanied by a Power Point
presentation. While a copy of the presentation was not provided,
its contents were detailed in Ms. Kah's narrative.]
Investment Criteria: Let me start by showing you the
general criteria we use at corporate headquarters to value
upstream investment opportunities. The first factor we
generally consider is the prospectivity of the country or
opportunity. We would consider such elements as the
maturity of the area, potential field size, remaining
reserves and the quality of the reservoirs and crude oil.
There are also a number of places around the world that
have known reserves but they are difficult to develop. The
larger the size of those reserves, the more feasible it
will be to economically develop them.
The second factor we generally consider is the cost of the
region or opportunity. This would include exploration,
development and production costs as well as transportation
costs to bring the crude to market.
The third criteria that is used to judge the value of
opportunities is the cycle time or the amount of time it
takes from exploration to first production. The value of
the project is highly dependent upon whether it can be
brought to the market quickly or whether it takes 7-8 years
or longer before first production.
The fourth factor we consider is the attractiveness of the
tax and fiscal terms and whether or not they are
commensurate with the prospectivity and cost of the region
or opportunity.
The fifth and last factor we consider is whether the
country has a strong rule of law and efficient regulations
for energy development. The stability of the political
regime and the fiscal terms are also very important
considerations in terms of the degree of risk that the
value will turn out to be significantly lower than we
anticipated.
With that said, let me show you how we would assess
Alaska's competitiveness using these criteria. I will start
with an overview of all of these criteria and then provide
more detail on a few of them.
Investment Criteria with Alaska Rating: Starting with
prospectivity, CRA has already showed that Alaska has fewer
and smaller field sizes than even the other mature areas in
OECD countries. The crude quality is moderately high sulfur
and getting heavier. These are negatives.
Alaska also has high exploration, development and
production costs, and a long cycle time to get to markets
given Arctic drilling conditions and limited drilling
seasons.
The strong rule of law and political stability have been
positive factors that explain why we have been investing in
Alaska all these years. However, we are now concerned at
the prospects of changing the tax regime after investments
have been made without grandfathering these investments
under the tax regime that was in effect when the
investments were undertaken. The worst thing that you can
do to an investor is to change the rules of the game after
the investment is made. This significantly raises Alaska's
risk profile and reduces the potential attractiveness of
investing there.
10:41:28 AM
Global Average Commercial Discovery Size: Looking at
prospectivity in greater detail, this slide compares the
average commercial discovery size in Alaska with various
countries around the world. Areas with high prospectivity
can generally assess higher tax rates, while maintaining
investment. The Alaska North Slope, however, has limited
prospectivity as compared to many parts of the world. Tax
rates need to reflect that.
But it is also important to acknowledge that although
exploration will continue to play a role in halting
Alaska's production decline, it will be a small one. Based
on the State's forecast, exploration will account for about
3% of production over the next 10 years and about 8% over
the next 20 years. Known discoveries which have yet to be
developed or are economically challenged, also play a small
part in Alaska's future.
The core legacy fields such as Prudhoe and Kuparuk will
still produce over 80% of the total North Slope production
in 2015, providing the base infrastructure on which these
smaller fields smaller fields will depend. Significant
capital will be required to maintain this infrastructure,
as well as, in-field drilling and well work to mitigate
decline. Discovered heavy oil resources would be included
in this category. However, the State's consultants
acknowledged that technology limitations and development
costs will constrain heavy oil production in the near term,
and it could be many years before this resource reaches its
production potential. The technology required to develop
this resource will require huge expenditures, which the
long-term major producers, such as ConocoPhillips, are more
likely to make than smaller companies.
Over the next 10 years, approximately 100% of the
investment in existing fields, 100% of the investment in
known discoveries, and probably about half of the
exploration investment (or about 98.5% of the total
investment over the next decade) will come from companies
that are already here. If you are interested in Alaska's
future, you are interested in seeing the major existing
players continue to invest here.
10:42:26 AM
Senator Bunde asked whether NPR-A and ANWR oil and gas reserves
were included in the company's future Alaska prospectivity
considerations.
Ms. Kah understood those fields were not included in the
company's prospectivity review. The information presented by the
company was based on estimates provided by the State Department
of Revenue.
10:42:45 AM
Increasing Production Costs: This slide compares the
production costs (increases severance but no other taxes)
of all of the major regions in ConocoPhillips' portfolio.
Alaska is the highest cost region in our portfolio. And
costs in Alaska are rising at a faster rate than in other
regions, in part because of the aging infrastructure and
declining field size. Cost also needs to be taken into
account when setting the tax take. The countries with the
lowest costs can afford to have higher tax rates while
remaining competitive. Similarly, higher cost countries
need to offset these conditions with lower tax takes.
Alaska - High Cost, High Tax: My next slide shows total
capital and operating costs as a function of government
take for about 30 countries/stated in the world. This data,
representing costs from 1994 to 2003, was taken from the
Wood Mackenzie 2004 "Global Oil and Gas Risks and Reward
Study" and was calculated at a $35 per barrel price. The
study included more countries but we removed the ones where
the government was carried through exploration in response
to the Legislature's consultant, Daniel Johnston's,
criticism of Wood Mackenzie for not accounting for this
carried equity in their government take calculation.
As can be seen, there are four quadrants shown on this
chart. The one on the bottom left shows countries that are
trying to attract investment. They have low costs and still
maintain low rates of government take. The quadrant on the
top left contains low-cost countries that are then able to
maintain high tax rates while remaining competitive. The
quadrant on the bottom right contains high-cost countries
but they compensate for their high costs by maintaining
lower tax rates. The quadrant on the top right contains
counties that have high costs and high taxes. Countries
that position themselves in this quadrant may not get
sufficient investment since their tax rates are not
commensurate with their cost structure.
This plot also shows that there are inverse relationships
between Government take and Total Costs. As previously
mentioned, high-cost countries often lower their tax rates
to remain competitive. The lower line tends to represent
net crude-importing countries who want to minimize
investment. The upper line tends to represent net oil-
exporting countries.
Alaska under the ELF is shown as the Red Triangle. The PPT
will move Alaska into the High-Cost, High-Tax Quadrant at
the same time that costs are rising at a faster rate than
in other locations.
This chart also shows with Green Triangles the OECD
countries that CRA believes are more appropriate peers.
Peer areas such as the Gulf of Mexico and the UK North Sea
are still significantly more favorable investment regimes.
The high cost in the Arctic and the types of fields that
are likely to be found suggest that the proposed fiscal
regime could detract, rather than encourage, significant
additional investment.
Ms. Kah specified that the horizontal axis on the charts
reflected total operating and capital costs. The vertical axis
reflected development only government take and net present
value. The purpose of this information would be "to show the
relationship between cost and overall government take". OECD
countries tend to fall into the lower left quadrant on the
chart. The PPT under SB 305, and the additional provisions added
by CSSB 305 would move Alaska into the high cost/high tax
quadrant. This would likely result in "reduced investment".
Senator Stedman asked regarding the definition of government
take in relation to the development only/government take
percentages depicted on the chart. The State's analyses would
indicate that Alaska's government take under CSSB 305 would be
approximately 60 percent. Thus, he was interested in the reason
the graph line depicted on the chart did not have "a more
vertical" upward trend to it.
10:46:25 AM
Ms. Kah clarified that the vertical slope of the line would be
more pronounced were cost increases excluded; however the chart
was intended to demonstrate that costs would increase "at the
same time". The slope of the line would also be elevated had
such things as the tax credits and other incentives in the PPT
been excluded from the calculations. In summary, the chart was
developed to reflect how an investor such as ConocoPhillips
would make development decisions on existing fields.
10:46:57 AM
Senator Stedman was puzzled that ConocoPhillips' chart depicted
the government take under ELF to be approximately 60 percent. A
60 or 61 percent level of government take would be expected
under CSSB 305. Therefore, he asked whether the industry was
anticipating "just a slight increase vertical" to result under
CSSB 305.
Ms. Kah reminded Senator Stedman that the company's calculations
did not exactly match those of the Legislature; such things as
the starting rates even differed. Thus, rather that guessimate
the differences, the entities should work together to identify
the reasons that the numbers differ. "Clearly we are not
comparing the exact same things."
10:48:08 AM
Mr. Bramley specified that the calculations on this chart had
been calculated differently as they included "a discounted
government take. In other words, in doing this analysis … a year
by year discount rate, as an investor would do," was applied.
That "would indeed have that effect of shifting all of the
points upwards." The analysis included in his earlier
presentation and the information in most other estimates had not
been discounted.
10:48:58 AM
Senator Stedman asked whether the chart could be redone to
reflect the provisions of CSSB 305 rather than SB 305.
Ms. Kah and Mr. Bramley replied in the affirmative.
10:49:21 AM
Senator Hoffman, noting that OECD countries were depicted on the
chart, asked the goals of that organization.
Ms. Kah expressed that OECD countries were simply "the total of
all the developed countries in the world", although recently
Korea and Mexico, which were once considered developing
countries, had joined the group. The OCED countries included in
this analysis were those which had a similar "political risk" as
Alaska. They were also chosen in terms of maturity and field
sizes.
Alaska - High Cost, High Tax (with prospectivity): Now I am
showing you the same slide but adding in bubbles to
indicate the prospectivity of some of these countries. You
can see that a number of the countries that have high tax
takes also score high in prospectivity. That is why they
can keep tax rates high and still be competitive.
The other point I wanted to make about this chart is that
the Governor's consultant assessed the competitiveness of
Alaska's tax rates by comparing tax rates of different
regimes around the world applied to similar-sized fields in
all locations. That is not the way investors look at it.
When we compare investments in Russia versus Alaska, for
example, we compare the prospects of accessing a very large
field with very high tax rates in Russia versus finding a
much smaller field with lower tax rates in Alaska. The
greater prospectivity in Russia may compensate for the
higher tax rates. Thus, it is not meaningful to compare the
competitiveness of Alaskan tax terms with Russia's terms or
those in Azerbaijan and Angola at the same field sizes.
Ms. Kah noted that this information was also based on the Woods
Mackenzie study earlier referenced.
Higher Taxes Will Reduce Investment: I will now switch
gears and talk about a concern I have with the testimony of
all of the state's consultants. They would have you believe
that you can raise tax rates without concern about
substantially reducing investment or production in the
state. This flies in the face of economic reality. To quote
a phrase from Dr. Margo Thorning, the Chief Economist of
the American Council on Capital Formation, "one of the
axioms of public finance scholars is that if you tax
something, you get less of it".
Ms. Kah was particularly concerned that other consultants had
communicated there would be little impact from increased taxes.
A substantial increase in taxes would impact investments.
10:51:27 AM
There are three reasons why higher tax rates will reduce
investment. The first is that there will be less cash flow
available to re-invest. Another less obvious reason is that
you have changed the risk/reward balance. You will
effectively increase the marginal cost of production and
thereby lower the rewards, while at the same time
increasing the perception of risk that the rules of
investment will be changed after investments are made.
Making the tax rate too progressive in a higher price
environment also negatively impacts the risk/reward balance
by shaving off the benefits of better times
disproportionately more than helping in a lower price
environment. Our industry invests a tremendous amount of
capital on projects with long lead times and significant
exploration, technical, price and economic risk. We need
the tax system to be stable and to allow us to keep enough
upside that we can earn adequate returns for our
shareholders on average over the long price cycles our
industry experiences.
The third reason why higher taxes will reduce investment is
that Alaska will be viewed as a less attractive place to
invest and capital will migrate to countries that have tax
regimes commensurate with their cost and prospectivity. The
state may also receive less investment from long-time
investors who believe they have been treated unfairly by
the state in the transition to a new tax regime by not
being given due consideration to recent investments made
with different fiscal regime expectations.
There are a growing number of countries around the world
who have increased their tax rates in this high price
environment, which is probably making you thing that Alaska
can still be competitive despite the proposed tax
increases. However, private investors will shift from
investing in conventional oil in all of these places with
higher tax rates to investing in LNG, downstream and other
energy projects that have more favorable tax terms. For
example, our company is now more willing to invest in
downstream and infrastructure projects than we were
historically when we believed that upstream investments had
higher and less risky returns. If current trends continue,
conventional oil will end up being the domain of national
oil companies who have lower return requirements than
private investors.
And finally, capital will flow out of the energy industry
if tax rates rise to the point that the energy industry
looks less attractive than other industries.
10:53:16 AM
Senator Stedman asked the government take for oil and gas in
Libya.
Mr. Bramley could not recall Libya's exact government take
percentage; however, it was "at the high end" of government
takes of countries having a "production sharing" tax regime.
That type of tax regime was fundamentally "a different structure
than the tax royalty regime" in Alaska and other areas. "In
terms of economic potential", a like for like comparison between
Alaska and Libya could not be drawn as Libya had a lower cost
base and larger fields. In addition its fields were closer to
the market than Alaska's. "The fundamentals are quite
different."
Ms. Kah communicated that while ConocoPhillips would be resuming
activities in Libya, its concentration would be on the assets it
had before the Libyan government imposed new sanctions. Those
assets, with a 200,000 barrel per day production, were not big
fields.
10:54:58 AM
Senator Stedman stated that the Libyan field production in 2004
and 2005, as reflected on the chart, indicated that the average
government take for Libya exceeded 90 percent. "That's a
substantial government take number…"
Ms. Kah pointed out that that was "an exact example of why we're
not investing as much in upstream, and we're investing in
downstream and infrastructure". ConocoPhillips could not invest
with those sorts of returns. She surmised that "the Independents
can't either. They have a higher cost of capital than us; and
therefore they should have higher return requirements. I believe
that only like the Chinese national oil companies and other
state oil companies would be able to invest in a sustained way
at….those lack of returns."
Co-Chair Green stated that the Committee would recess until
after the Senate floor session. Ms. Kah would continue her
presentation at that time.
RECESS TO CALL OF THE CHAIR 10:56:01 AM / 12:31:00 PM
Ms. Kah continued reviewing the power point presentation slide
titled "Why higher taxes would reduce investment". The
conclusion is that higher taxes would reduce industry's "after
tax cash flow so we have less money to invest; it changes the
risk/reward balance in Alaska; and also capital will go
elsewhere." Capital would go to other countries in a company's
portfolio and to other energy sources … because the company has
determined that "with increased tax rates in some countries
around the world that we can't invest profitably in them. And
finally our entire industry is going to lose capital if tax
rates were to price our industry out of the market and we don't
get acceptable enough returns for our shareholders."
12:31:48 PM
Co-Chair Wilken agreed with the argument that "when you tax
something you are going to get less of it". His question was
whether "the general point" of ConocoPhillips's presentation was
to the specific impact of the 25/20 tax structure proposed under
CSSB 305 or whether it took into consideration other elements of
the bill such as credits.
Ms. Kah qualified that she was speaking to the entire bill. "The
tax credits definitely do not offset the much higher tax rate.
The overall tax rate is far more important in terms of the
economics, and certainly at this price level, it's a five to one
ratio of being more important."
Co-Chair Wilken cited there having been "general agreement among
the Governor and you folks at the 20 percent rate and then the
other four or five major pieces. So what we are really talking
about at this table is 25 or 20. So that difference is what your
concern is …that that marginal difference is what's going to
drive investment away."
Ms. Kah clarified that she had concerns about the 20/20 tax
proposal in SB 305. Whether or not it was the right strategy,
"companies reluctantly agreed to that just to get to the gas
deal. But really it's on the outer edge of acceptability and
won't encourage investment".
Senator Bunde recalled discussions in which the industry had
urged for "certainty" in a tax structure. To that point, were
the State's tax regime to include "a re-opener every five years,
perhaps we'd approach it a different way." However, the tax
proposal under consideration would not have a re-opener for
thirty years or more. "That has to factor into these
discussions."
12:34:19 PM
Ms. Kah concurred. "There is certainly a value to certainty and
I believe we are taking that into account when we view the
overall fiscal package."
COP Major Upstream Projects: While I believe there will
likely be a long-term adverse impact on investment from
rising tax takes around the world, let me bring the
discussion back to corporate allocation decisions we face
in the next 15 years.
This slide represents the pipeline of upstream investments
ConocoPhillips is pursuing in the next 5 years. We are
planning on continuing investments in our base legacy OECD
areas, such as Alaska. But we also are planning investments
in global gas and other international areas. Investments in
Alaska must be able to compete with investments in these
other areas. The tax rate needs to be commensurate with
Alaska's high cost and low prospectivity to ensure this
state maintains its important place in our investment
portfolio.
Ms. Kah stated that were the State's tax regime to change "in an
unfavorable way", ConocoPhillips might be required "to make
tough choices" about which of the projects in its portfolio "go
forward, which get deferred".
12:35:25 PM
Senator Bunde stated that the "rhetorical question" is, were the
State to guarantee a 15/20 tax rate, could ConocoPhillips
"guarantee us a certain amount of investment in the next ten
years. Certainty goes both ways."
Ms. Kah acknowledged the underlying message in the question.
Portfolio Ranking: Another concern I have with the state
consultants' assessment that Alaska can raise its tax rate
without hurting investment is their implicit assumption
that all projects with a positive net present value will be
undertaken. That assumes that there is unlimited human and
financial capital. Our shareholders expect companies to
exercise capital discipline and to avoid doing marginal
projects. We also have limited manpower and focus on
projects that have sufficient scale to make a difference to
the company.
As indicated in this concept slide, when Alaska raises its
tax rates, some projects, like Alaska project number one,
will still be in the competitive range but it may be moved
down to a lower ranking than other projects the company is
planning on, such as upstream project number one and the
downstream project shown here. Other projects, like Alaska
project number two could slip from being competitive to
being deferred. And finally, some projects, like Alaska
project number three could slip into the uncompetitive
range.
Ms. Kah stressed that, were taxes increased, not all projects
having a net present value above zero would be undertaken;
competition would exist within the Company's portfolio.
12:38:18 PM
In order to better understand the intent of this concept slide
in relation to this bill, Co-Chair Wilken asked whether
exchanging the words "'before tax increase' with 'before SB 305
and after SB 305'" would be "appropriate and correct".
Ms. Kah affirmed, but clarified that regardless of the tax
levels proposed in these bills, any tax increase would cause
projects to be re-evaluated.
What's Wrong With Windfall Profits Taxes: The proposed bill
has a surcharge based on ANS West Coast oil prices over $40
per barrel. This is tantamount to a windfalls profit tax
because it shaves off the upside without helping on the
downside.
The U.S. federal government has recently debated the merits
of a windfall profits tax on domestic production, and this
concept drew great criticism from a broad range of
economists and investors across many industries. I have
provided two quotes that represent the criticism of such a
tax. Daniel Yergin of Cambridge Energy Research Associates
stated in an interview that "what a windfall profits tax
does is introduce a lot of distortion. It reduces
investment, it increases a sense of political risk and it
doesn't achieve the goal that is intended…it will really
lead to decreased supply". A group of 250 economists from
academic and other institutions across the nation,
including Milton Friedman, the Nobel Laureate in Economics,
recently sent a letter to the U.S. Congress stating their
opposition to such a tax, indicating that it would reduce
domestic production and expressing sadness that politicians
hadn't learned any lessons from past experience with this
type of tax.
The non-partisan U.S. Congressional Research Service (CRS)
assessed the impacts of the federal windfall profits tax on
domestic crude production that was in effect from 1980 to
1988. CRS concluded that the tax reduced industry gross
revenues by $79 billion that could otherwise have been used
for investment. As a result, the tax was estimated to have
reduced domestic production by up to 1.6 billion barrels
between 1980 and 1986, before the collapse in oil prices.
It also increased oil imports by up to 16% during this
period. The study also noted that the actual gross tax
revenue collections were only 20% of what the federal
government had expected. This was because prices did not
remain at the very high levels of 1980 and domestic
production ended up lower.
12:41:21 PM
Value Uncertainty in Balanced Government Take: Now I want
to demonstrate how a windfall profits tax would impact our
project economics and investment decisions. In evaluating
investment opportunities, ConocoPhillips considers risk and
opportunities associated with an investment. Assuming a
stable fiscal environment, factors that most often impact
our North Slope investments are:
· Oil price uncertainty, which accounts for the majority
of NPV variance,
· Reserves and capital spending,
· Operating costs, and
· Schedule, which is particularly important in Alaska as
construction windows are limited. Missing a key
construction window (e.g. a sealift) can easily delay
the project by a year
The impact of the sensitivities for these key variables are
demonstrated in a chart called a Tornado Diagram. In a
Tornado Diagram, the impact of a given variable on the
project value is tested by holding all other key variables
at their mean value and varying the variable being tested
through the high and low end of its expected ranges. For
example, in the tornado diagram pictured on the left, the
price bar is truncated so that there is more downside than
upside price risk. After running all the probabilistic
simulations, this would shift the cumulative probability
curve to the left so that the project loses money 53
percent of the time and has a positive net present value
only 47 percent of the time. The expected value, reading
across to the 50th percentile is now slightly negative.
This decrease in project value is purely associated with
reducing the upside potential associated with oil price. In
other words, shaving off higher price risk creates greater
risk that the project will not increase value. Thus, the
project will probably not be approved.
Ms. Kah communicated that since the industry incorporated
"conservative price assumptions" such as a $35 per barrel in its
economic calculations, "people think" what would "be wrong with
taking away the upside". However, no single price was the basis
of the industry's economics. The tornado diagram depicted on
this power point chart further explained how the industry
"actually values investments". Typically, a price range of $20
to $80 per barrel would be considered and factors would be
applied to that range to gauge their affects. "The price of oil
by far" would create the biggest uncertainty for a project. 80
percent of the variances in projects were due to changes in the
price of oil. "Probabilistic weightings" are applied to the
various prices.
Ms. Kah explained that "the simplest distribution" would be "to
assign a 50 percent weight to the mean price, 25 to the high
price, and 25 to the low price". Similar probabilities would be
applied to other economic factors such as reserves and capital
operating costs. Thousands of multilayered simulations were
applied in the effort to develop a cumulative probability curve
which would "show you the probability that the project will have
either a positive or negative net present value." The risk of
having a positive or negative net value would be depicted
"across a range of prices and all these other variables". She
reviewed the example depicted on the chart.
12:44:10 PM
Senator Stedman understood that the project exampled on the
chart illustrated the concept of the process rather than a real
scenario. Since, oil prices were the real issue of concern, a
project's modeling would be affected by the proposed
Progressivity factor since it "would shave off some of the
upside". To that point, he asked whether the economic modeling
of a project with a $20 to $80 price range would be treated as
an "equally distributed price range".
Ms. Kah responded no, "the usual assumption we make about prices
is that they're log-normally distributed and they're not
normally distributed; they cut off at the bottom 'cause you
start getting into shut-in costs quickly and they tend to spike
up".
Senator Stedman understood therefore that the modeling would be
"skewed to the right, substantially".
Ms. Kah affirmed. "That's what we're taking into account when we
look at our upside. The upside is why our shareholders invest in
energy stock."
Senator Stedman surmised that the presentation would also
address "the impact of taking away the upside".
Ms. Kah confirmed.
Senator Stedman asked that "the magnitude" of that impact on the
upside be discussed, "as clearly there's a impact, but what
we're looking at is … a slight change" as the analysis conducted
by the Administration indicated that the State's government take
numbers would remain fairly constant going forward under CSSB
305.
12:46:17 PM
Ms. Kah expressed that, while the projects presented in her
presentation were fictitious, the majority of ConocoPhillips'
projects mirrored the examples. She reiterated that price
accounted for 80 percent of the risk in a project. Capital,
reserves, operating costs, and schedules were also risks
experienced in Alaskan projects.
Balanced and Progressive Value Uncertainty Comparison: this
slide summarizes how shaving off the upside price risk
reduces the change that the project will be profitable and
reduces the expected value. In this case, the project is
far less likely to be undertaken without upside price risk.
It is also important to understand that our shareholders
invest in energy companies because they want to be exposed
to upside price risk. We will have trouble attracting
capital if we were no longer exposed to this risk. Being a
high cost area, Alaska in particular, is a high-price play,
and shaving off the upside will disproportionately impact
investment in the state.
Ms. Kah reviewed the impact of "shaving off the price upside".
It would remove real value and thus the expected value would
decrease. The reason that a project could easily shift from
being positive to negative is "that this was probably a marginal
project to begin with". It would be likely "given the maturity,
cost, and prospectivity issues in Alaska, that a lot of the
projects" being considered "are marginal".
Ms. Kah compared the two graphs. "It looks like a very subtle
shift but what has happened is that there is a greater chance of
loosing money than there was before and you are less likely to
do the project now than you would have before."
Ms. Kah stressed that "we do take account of the upside price
risks. Our shareholders invest in our stock because they want to
be exposed to the upside price risk and we do value it in our
economics." Removal of the upside price risk would have an
impact, "even if that isn't our mean belief of what we believe
prices" would be in the future.
12:48:46 PM
Co-Chair Wilken furthered the position that as the price of ANS
increased, industry costs would "only increase at an incremental
amount". CSSB 305 would result in "a flat government take" out
to a range of approximately $120 per barrel. The citizens of the
State, who could be considered State shareholders, relied on
Legislators "to make sure that we get our fair share, and our
fair share is that the government take at $40 is the same at
$120." He also considered it "perfectly appropriate to have a
progressivity factor". Where ConocoPhillips to benefit "by the
market", the people who own the resource should also "benefit by
the market"; that concept is what is embodied in the PPT. This
is the concept he supported provided that the State's take
remained constant rather than getting "exponential" as prices
increased.
Ms. Kah argued that the State would benefit as prices increased.
"Even if you held your percent the same" as revenues increased
the State would get more rather than being "held flat".
Mr. Bowles emphasized ConocoPhillips's desire to continue to
operate and invest in Alaska. "One of the key premises" stressed
today "is that there are numerous locations" worldwide that
companies operating in Alaska consider in their investment
portfolio. "It's not so much of what's fair to the State or fair
to the company" as much as it would be to "what you want to see
developed in the State … It's your call at the end of the day of
how much take that you want, but" companies might determine,
"even it it's a flat take at higher prices", that other regions
tax regimes were "more attractive", as expressed in Mr.
Bramley's OECD presentation.
Co-Chair Wilken responded "that's fair".
Finding, Developing & Production Costs: This last point I
want to make about a windfalls profits tax is that some of
what is being perceives as a windfall is actually higher
reserve replacement costs. Let me explain.
While price increases across all of our energy products
have recently increased our industry's earnings to record
levels, it is only temporary as we are also experiencing
enormous cost inflation as the industry ramps up its
investments to increase supplies. This chart shows that
industry finding, developing and production costs have more
than doubled since 1999, excluding government take. F&D and
production costs are the components of replacement cost
most quoted because they are the easiest to measure in the
financial statements of oil companies. However, this chart
is missing a number of the components of reserve
replacement costs. It is missing all government take, which
on average was probably about $20-25 per barrel in 2005. It
is also missing a cost-of-capital return and an adjustment
reflecting compensation for the time value of money because
you are spending money in year zero and getting production
and revenues many years later. If replacement cost is being
stated in terms of WTI prices, these numbers are also
missing additional quality and transportation costs because
most crudes are more remote and lower quality than WTI.
When you add all these costs up, it is easy to see that
replacement costs today are probably over $50 per barrel.
In fact, several financial analysts (e.g., Goldman Sachs,
Bernstein) who track the energy business believe that long-
term reserve replacement costs today are over $50 per
barrel when government take and the increased risk around
cost uncertainty are included in the cost calculation.
While oil prices may have peaked, spending levels and costs
are continuing to rise. Some of this inflation reflects
temporary conditions such as service industry capacity not
keeping pace with industry spending levels and the high
cost of materials like steel due to particularly strong
industrial growth in China. Some of the cost increase is
structural, and more permanent, though, reflecting the fact
that our industry is investing in prospects that are
smaller, more complex or remote and higher cost.
We are concerned that some of what people perceive is a
"windfall" today actually reflects the tremendous cost
inflation that has taken place in the industry. In
addition, the size of the major's earnings sounds large to
most people but it reflects the scale of our business and
required investment levels and enormous risk involved in
replacing reserves.
This matters because if the alleged "windfall" is taxed at
higher rates and reserve replacement costs really are
between $50-60 per barrel, our industry will not be able to
profitably re-invest even at today's prices.
Key Messages from Corporate Perspective: I will stop here
and summarize my key messages.
· It is our opinion that the current tax regime isn't
competitive when compared with Alaska's prospectivity
and cost versus the other opportunities we have to
invest in around the world.
· Thus, we believe that increasing the tax rate will
significantly reduce our investment and production in
Alaska.
· We are also concerned about the windfall profits tax
the CS would put in place as it would reduce the cash
we have to invest, and it would adversely impact the
risk/reward balance of investing in Alaska.
· The federal government has tried a windfall profits
tax in the past and it reduced investment and
production and failed to generate the expected
revenues.
ConocoPhillips has been a long-term investor in Alaska.
Including our heritage companies we have more than 50 years
of business history in Alaska. We believe there can be a
great future in this state, and although mature, there
remains a lot of potential. We want to be part of this
future.
12:55:55 PM
Senator Stedman recalled that the oil and gas industry
experienced $12.75 billion in gross revenue in FY 2005. This
netted producers approximately 37 percent or $4.7 billion. The
government take of the industry share after costs was 45
percent. That would appear "to be a fairly profitable business
regardless" of industry's position. This revenue was generated
on an average oil price of $43 per barrel. Prices are currently
considerably higher than that of FY 2006. This would result in
more revenue to the producers and federal and state governments.
While Alaska reaped substantial returns at the $43 per barrel
price, a price of $20 per barrel would be harmful to all
entities.
12:57:25 PM
Ms. Kah acknowledged that the oil and gas industry experienced
record earnings in 2005. Their spending level could not keep
pace with the swiftness of rising prices. "But what we quickly
found was that when we tried to reinvest and look at new
projects at today's cost levels, nothing looks economic. It's
actually frightening to us"…. thus, the development of this
forward looking concept. The typical industry profit margin,
even in the year 2007 would be 7.5 cents per unit of sales.
Numerous other industries experience higher profit margins.
"This is not a particularly attractive industry" even though
2005 was well above an average price cycle. "But we need years
like that to offset years such as 1998 where the industry was
well below the cycle. A decent return over a ten year cycle"
would be desired.
Senator Stedman acknowledged.
Senator Stedman noted that barrel prices have escalated in
recent years to the $60 range. Continuing, he asked how long the
$20 to $80 range has been used in the industry forecasting
modeling, as the forecast must have been adjusted to reflect
changing times at some point.
Ms. Kah stated that price range was implemented in 2005. The
price range might have included a high of $75 previously. The
industry however, always included a spike on the price high side
due to the log-normally distribution nature of the industry.
12:59:29 PM
Mr. Bowles summarized key points in the presentation.
ConocoPhillips "fully supported the idea of a percent of
government take that's competitive and that could be used as a
yardstick as far as how you set the production tax rate that
we're looking at today". ConocoPhillips asked the Committee to
consider "one message" in the effort to determine an appropriate
tax rate: that being that the OECD countries be considered as
"the core competitors" for the capital that might be invested in
Alaska.
Mr. Bowles also pointed out that there is "a direct connection"
between increased taxes and investment and jobs. Increased taxes
would reduce industry capital and would affect the industry's
risk/reward economic decisions. The risk/weight economic
modeling utilized by ConocoPhillips was a standard industry
approach to considering whether a project would be undertaken.
Mr. Bowles professed there to be "a fine balance" in determining
a correct tax level. A "tax increase that goes too far" could
"take more value away from the State than what" it would
generate in the short term. He encouraged the Committee to ask
other consultants to comment on some of the ideas being
presented in this testimony.
Mr. Bowles noted that whether or not the 20/20 proposal
presented in SB 305 would strike the right balance was difficult
to predict. However, it would "be fair to say that it did strike
a balance and it was something that the industry was prepared to
go forward with". The addition of the Progressivity element in
CSSB 305 "is something that does definitely take away the upside
and is an item" that would affect any company's decision about
whether or not to advance projects in Alaska.
1:02:26 PM
Mr. Bowles noted that, while the presentation had not addressed
the bill's transition provisions, ConocoPhillips had reviewed
the transition look-ahead provisions included in CSSB 305. The
look-ahead provisions were evidence that the Senate recognized
that investments made during the last five years, some of which
had not yet produced any oil, were made under a previous "set of
rules and tax forecasts". The look-ahead provisions which would
allow a two dollar investment to receive one dollar in credits
"would effectively offer an incentive" to a company which had
made investments during the past five years. This was an example
of many right balances that could be included in the bill.
Mr. Bowles favored SB 305's July 1, 2006 start date or a later
date rather than the April 1, 2006 start date included in the
committee substitutes. A start date later than July first would
provide more time for companies to adjust to the changes in the
tax regime.
Senator Stedman asked whether the industry considered the five
year look-back and five-year look-ahead provision specified in
the transition provisions of the bill to be sufficient time in
which to conduct exploration and development activities in
consideration of worldwide equipment and labor constraints.
Mr. Bowles appreciated the question. ConocoPhillips would
consider a look-ahead recoupment period of seven or eight years
on a five-year dollar look-back to be more appropriate. Rather
than a company being unwilling to invest at a level in which
their "expenses could be fully recouped", delays might be caused
by other limitations such as equipment and labor constraints.
1:05:57 PM
Co-Chair Green reiterated that Members should notify her of any
subjects they would like included in the set of questions being
developed.
Senator Hoffman asked whether the Alaska Permanent Fund
Corporation (APFC) had invested in ConocoPhillips.
Mr. Bowles understood that, while APFC wished that some
investment had been made in companies investing in the State, no
such investments had been made. This could be part of the
"alignment" issue discussion.
Co-Chair Green stated that public testimony on the PPT bill was
scheduled for Saturday, April 8th.
Co-Chair Green reminded the Committee that a joint hearing with
the House Finance Committee would convene this afternoon. A
presentation on the Alaska Gas Pipeline Project would be
conducted by Econ One Research, Inc.
The bill was HELD in Committee.
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