Legislature(2003 - 2004)

05/07/2003 03:37 PM Senate RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
     CSHB 61(FIN)-OIL & GAS TAX CREDIT FOR EXPLORATION/DEV                                                                  
                                                                                                                                
REPRESENTATIVE  MIKE CHENAULT,  sponsor  of HB  61, told  members                                                               
this legislation  creates a  new income  tax credit  to encourage                                                               
increased exploration  and development  for natural  gas reserves                                                               
south of the  Brooks Range. He explained that to  qualify for the                                                               
credit,  operators  must  successfully   drill  and  develop  new                                                               
reserves  and  produce natural  gas  for  sale and  delivery.  He                                                               
described HB 61  as a "successful efforts" bill,  meaning that no                                                               
credits  will be  given  for  dry holes  or  for  wells that  are                                                               
capped. He  said the Cook  Inlet and  other areas in  Alaska have                                                               
great potential  but face high development  costs and exploration                                                               
risk. By  providing the credit  for the successful  efforts, more                                                               
exploration will  occur, leading to  much needed new  natural gas                                                               
reserves. This  will benefit the  residents and businesses  at no                                                               
direct cost  to the state.  Increased drilling will also  aid the                                                               
general economic  status of  areas such  as the  Kenai Peninsula,                                                               
and Anchorage.  In his  opinion, the  increased tax  revenue from                                                               
additional  gas  production  will  more than  offset  any  fiscal                                                               
impact from the proposed credit.                                                                                                
                                                                                                                                
SENATOR SEEKINS  referred to Version  S and noted  the definition                                                               
of a binding  payment agreement on line 5. He  asked whether that                                                               
is essentially an IOU.                                                                                                          
                                                                                                                                
MR. MARK GRABER, Department of  Revenue (DOR), said he interprets                                                               
a  binding payment  agreement to  mean  a contract  for a  future                                                               
purchase.                                                                                                                       
                                                                                                                                
SENATOR  SEEKINS asked  if DOR  would consider  a contract  for a                                                               
future purchase as  an expenditure in the  exploration of natural                                                               
gas.                                                                                                                            
                                                                                                                                
MR. CHUCK  LOGSDON, DOR,  said the binding  agreement would  be a                                                               
contractual obligation to make a payment.                                                                                       
                                                                                                                                
CHAIR  OGAN  asked  if  there  would  have  to  be  a  contracted                                                               
expenditure for developing that particular field.                                                                               
                                                                                                                                
MR. LOGSDON said, "Yes, exactly."                                                                                               
                                                                                                                                
SENATOR BEN STEVENS  noted the bill refers  to expenditures under                                                               
(a)(1)  [page 2,  line 5],  in the  amount of  10 percent  of the                                                               
taxpayer's  qualified capital  investments; cash  expenditures of                                                               
binding payment  agreements. He said  he would interpret  that to                                                               
be a binding payment agreement,  which would be, for example, the                                                               
interest  on a  10-year note  for  $10 million  that an  investor                                                               
borrowed, or the cost of borrowing capital.                                                                                     
                                                                                                                                
SENATOR SEEKINS said  he understands that but he  could read this                                                               
to  say that  before he  went  into production,  during the  time                                                               
frame when  he could  use the  capital expenditures  to get  a 10                                                               
percent  tax  credit,  if  he  were to  have  a  binding  payment                                                               
agreement  down the  line,  he could  ask for  a  10 percent  tax                                                               
credit  on  expenditures  he  had not  yet  made.  He  questioned                                                               
whether that was the intent.                                                                                                    
                                                                                                                                
SENATOR  BEN STEVENS  said he  interprets that  clause to  say 10                                                               
percent  of the  total  investments  can be  applied  to the  tax                                                               
credit. Therefore, the  total investment would be  some cash plus                                                               
borrowed money.  The tax credit  does not come into  effect until                                                               
that investment  begins to produce  revenue. In other  words, the                                                               
cost  of borrowing  capital is  included in  the investment  cost                                                               
because one can forecast what the  total payments will be for the                                                               
investment. He  said he understands  Senator Seekins'  point that                                                               
the company will  be taking a credit on something  it has not yet                                                               
paid, but that is the cost of the investment.                                                                                   
                                                                                                                                
SENATOR SEEKINS said  he would consider it to be  the cost of the                                                               
investment  up  until the  point  that  a well  began  producing.                                                               
However,  if  the  money  borrowed  also  included  the  cost  of                                                               
something for  the development after  the well began  to produce,                                                               
that is outside the original intent.                                                                                            
                                                                                                                                
SENATOR WAGONER  said another point  is that a company  will have                                                               
financing  for other  aspects of  the development,  not just  the                                                               
well.                                                                                                                           
                                                                                                                                
CHAIR OGAN asked Mr. Logsdon  his interpretation of that language                                                               
on page 2, line 1, regarding future contracts.                                                                                  
                                                                                                                                
MR. LOGSDON  responded, "I think  the discussion that  preceded -                                                               
there's something  different than a cash  expenditure, the intent                                                               
is  to cover  the cost  of acquiring  the assets  that allow  the                                                               
development of the gas field."                                                                                                  
                                                                                                                                
MR. KEVIN TABLER,  manager of Union Oil  Company, thanked members                                                               
for  considering  this legislation  and  informed  them that  the                                                               
qualified capital  investments are  listed in  (i)(1) on  page 3,                                                               
line 23. He then gave the following testimony.                                                                                  
                                                                                                                                
     Although [Union  Oil] recognizes this bill  may improve                                                                    
     the economics of marginal  oil reservoirs discovered or                                                                    
     defined   while   exploring   for  gas,   it   is   the                                                                    
     identification and  development of new gas  reserves in                                                                    
     Cook Inlet which are desperately  needed if we're going                                                                    
     to sustain  our local  economy in  Southcentral Alaska.                                                                    
     Without  new gas  reserves, value-added  businesses and                                                                    
     industrial   exporters   will    suffer   cutbacks   in                                                                    
     production, yielding  to the  ever-present Southcentral                                                                    
     utility  needs. These  disruptions  and supplies,  left                                                                    
     unchecked,   will   lead   to   a   lower   tax   base,                                                                    
     unemployment, underemployment and  loss of the monetary                                                                    
     cycling effect  as dollars change hands  throughout the                                                                    
     community.                                                                                                                 
                                                                                                                                
     I  place an  emphasis on  Cook Inlet  as Cook  Inlet is                                                                    
     where  Unocal's  infrastructure  base and  manpower  is                                                                    
     best [indisc.]  Although we  do have  working interests                                                                    
     in fields  on the  North Slope, our  ownership interest                                                                    
     there  is  such  that  we  have a  minor  role  in  the                                                                    
     exploration and  development of the operation  of those                                                                    
     fields.  While we  recognize that  incentives available                                                                    
     to  North Slope  explorers  and producers  will have  a                                                                    
     beneficial impact  on Unocal, the beneficial  impact of                                                                    
     incentive legislation  in Cook Inlet is  magnified when                                                                    
     applied  to the  marginal nature  of the  mature fields                                                                    
     and the declining  gas reserve base in  Cook Inlet. For                                                                    
     this reason,  incentive legislation such as  HB 61 will                                                                    
     help  achieve that  desired effect  of identifying  new                                                                    
     gas   reserves   by   providing   a   predictable   and                                                                    
     quantifiable credit  to help  lessen the  inherent risk                                                                    
     of costly  exploration. The increased tax  revenue from                                                                    
     additional  hydrocarbon   production  will   more  than                                                                    
     offset  the  initial  financial  impact  from  the  tax                                                                    
     credit. The objective is not  to shift the larger share                                                                    
     of the  existing pie to industry;  rather the objective                                                                    
     is to increase the size of the pie for everyone.                                                                           
                                                                                                                                
     Unocal's   considerable  stake   in   its  Cook   Inlet                                                                    
     infrastructure,  manpower, and  capital investments  is                                                                    
     continually threatened  by internal  global competition                                                                    
     for investment dollars.  Evidence of this vulnerability                                                                    
     is confirmed by the recent  drilling of three dry holes                                                                    
     on the Kenai  Peninsula by Unocal in an  effort to meet                                                                    
     the growing demand of the  natural gas market. Although                                                                    
     we were rewarded  by a discovery in  our Ninilchik unit                                                                    
     with our  partner, Marathon, an uncertainty  of success                                                                    
     has reduced  our capital budget  from $75  million last                                                                    
     year down to $35 million  in 2003. Providing us credits                                                                    
     for  successful  efforts  will definitely  improve  the                                                                    
     attractiveness of our Alaskan exploration projects.                                                                        
                                                                                                                                
     Not only will  HB 61 create an  incentive for companies                                                                    
     currently active in gas exploration  in Cook Inlet, the                                                                    
     attractiveness of  such credit will act  as an industry                                                                    
     incentive   to   those   thinking   of   investing   in                                                                    
     exploration south of the Brooks  Range. If you think of                                                                    
     the  credit  as costing  the  state  $1 for  every  $10                                                                    
     invested  by  someone  else  and paid  out  only  in  a                                                                    
     success scenario,  the risk to  the State of  Alaska is                                                                    
     negligible  when compared  with the  ancillary benefits                                                                    
     of new reserve identification.                                                                                             
                                                                                                                                
     In  conclusion,  Unocal  believes this  bill  will  add                                                                    
     certain attractive  parameters to the  companies during                                                                    
     the  investment   decision-making  process   with  very                                                                    
     little exposure  to the State of  Alaska. Therefore, we                                                                    
     encourage  your  passage  of  this  bill  out  of  your                                                                    
     committee. Thank you for the  opportunity to speak and,                                                                    
     if I can, I will answer any questions you may ask.                                                                         
                                                                                                                                
CHAIR  OGAN  noted  that  members   had  no  questions.  He  then                                                               
continued taking testimony.                                                                                                     
                                                                                                                                
MR.  JOHN BARNES,  production manager  of Marathon  Oil Company's                                                               
Alaskan  operations,  thanked members  for  the  time they  spent                                                               
earlier  with   him  discussing  the  bill.   He  clarified  that                                                               
Marathon's view  of the definition of  binding payment agreements                                                               
is that  they could  include two types  of situations.  The first                                                               
would   be   for  progress   payments   for   a  major   facility                                                               
installation,  which  often extend  beyond  the  date of  initial                                                               
production. He  pointed out that one  of the changes to  the bill                                                               
made  by  a previous  committee  was  on page  2,  line  8.   The                                                               
provision "through  the date  the reserves  produce gas  for sale                                                               
and delivery;" is  a trigger point in the bill.  If a company had                                                               
a  binding progress  that  came  up after  the  initial gas,  the                                                               
intent was  to include that  cost. Also,  if a small  operator is                                                               
unable to  self-finance a project and  seeks financing elsewhere,                                                               
the  bill  recognizes  the  payment  scheme.    He  then  gave  a                                                               
Powerpoint presentation, the highlights of which follow.                                                                        
                                                                                                                                
   · Marathon believes HB 61 will draw more exploration and                                                                     
     production investments  to the State of  Alaska. The primary                                                               
     focus is  on the  Cook Inlet,  but it  would apply  to other                                                               
     Alaska  sedimentary  basins that  are  south  of the  Brooks                                                               
     Range.  The focus  is  on  natural gas  for  which there  is                                                               
     competition for funds on an  international basis. The intent                                                               
     is to tilt the playing field toward Alaska's direction.                                                                    
   · HB 61 applies to 10 percent of qualified capital investment                                                                
     and  10   percent  of  qualified  expenses.   Looking  at  a                                                               
     timeline, a producer must explore  and find gas, develop it,                                                               
     and  put  it  in   initial  production  -  four  significant                                                               
     hurdles. The producer cannot apply  for the credit until all                                                               
     four  hurdles  have been  overcome.  This  incentive can  be                                                               
     factored into  project economics. When a  company is looking                                                               
     at investment  opportunities, HB 61  lays out a  tax credit,                                                               
     allowing a  company to see  in black  and white the  cost of                                                               
     doing business in Alaska.                                                                                                  
                                                                                                                                
TAPE 03-42, SIDE B                                                                                                            
                                                                                                                                
SENATOR LINCOLN  interrupted to note that  Marathon Oil describes                                                               
HB 61  as only applying  to successful  efforts and asked  how it                                                               
defines  "successful." She  then  asked what  would  happen if  a                                                               
discovery ends  up being  very small and  would not  otherwise be                                                               
economical to get to market.                                                                                                    
                                                                                                                                
MR. BARNES  said the tax credit  does not apply until  the gas is                                                               
brought to  market so, while  a company can accumulate  the costs                                                               
of the  funds expended up  to the  point of first  production, if                                                               
the gas does not go to market,  the state will not be impacted at                                                               
all. He said  "successful efforts" is defined as at  the point at                                                               
which gas is produced into the marketplace.                                                                                     
                                                                                                                                
SENATOR LINCOLN asked  if the quantity does not  matter, the only                                                               
thing that does matter is getting the gas to market.                                                                            
                                                                                                                                
MR. BARNES  said the  presumption would be  that a  company would                                                               
not  invest in  a non-economic  project. The  risk on  capital is                                                               
much  higher than  the 10  percent credit.  A company  would make                                                               
incremental  decisions  during  each   step  of  the  exploration                                                               
development  process,  based  on  the   belief  it  will  have  a                                                               
successful project. If, at some  point, the project looks like an                                                               
unsound  return,  the company  will  most  likely decide  not  to                                                               
proceed.                                                                                                                        
                                                                                                                                
CHAIR  OGAN asked  if a  company drilled  four wells  off of  one                                                               
platform and  only found  gas in  one of  the wells,  whether the                                                               
company could take the investment credit for the four wells.                                                                    
                                                                                                                                
MR. BARNES said the intent is to  find new gas so if the platform                                                               
was a  new installation, the  entire cost cycle would  be subject                                                               
to the tax credit for funds  spent until first production. If the                                                               
well was a new discovery  from an existing facility, credit would                                                               
only be given for the cost of that well.                                                                                        
                                                                                                                                
CHAIR OGAN asked about workovers.                                                                                               
                                                                                                                                
MR. BARNES said workovers are unlikely to be new reserves.                                                                      
                                                                                                                                
SENATOR DYSON  asked if 10 wells  are drilled from a  jack-up rig                                                               
and one well  produces commercial quality gas,  whether a company                                                               
would get credit for the other nine.                                                                                            
                                                                                                                                
MR.  BARNES  said  that  most often  in  offshore  production,  a                                                               
company  does a  significant  amount of  forward  spend prior  to                                                               
first production, the  reason being that a company  wants to come                                                               
on production at  the highest rate possible. At the  same time, a                                                               
company is  making efforts to accelerate  production. As written,                                                               
HB 61 would include all expenditures  up until the point of first                                                               
production. Therefore,  if a company  drilled three  wells before                                                               
it put  in an  offshore pipeline, then  the credit  would include                                                               
all  of those  expenditures.  He said  although  the state  would                                                               
spend 10 percent, the company would be spending 90 percent.                                                                     
                                                                                                                                
SENATOR DYSON  asked if that  would include the wells  that don't                                                               
produce.                                                                                                                        
                                                                                                                                
MR. BARNES said he does not believe so.                                                                                         
                                                                                                                                
SENATOR  DYSON said  Mr.  Barnes could  get back  to  him with  a                                                               
definitive answer later.  He asked, if Mr.  Barnes determines the                                                               
state will not  give credit for the  non-producing wells, whether                                                               
the cost of the jack-up rate would be prorated.                                                                                 
                                                                                                                                
MR.  BARNES said  that is  probably an  unlikely event  because a                                                               
jack-up will  come in and  drill the exploration well  and leave.                                                               
The company  would then put a  facility on the property  for full                                                               
development. A  jack-up typically  drills one or  two wells  on a                                                               
structure to  explore and delineate  so those would  be included.                                                               
He stated:                                                                                                                      
                                                                                                                                
     This  is   probably  a   policy  decision   that  would                                                                    
     basically say  if you drill  a top  [indisc.] structure                                                                    
     well and  you find something  and you drill  down below                                                                    
     and you don't, a company would  see that as the cost of                                                                    
     development. The  State of Alaska  might not.  I think,                                                                    
     after looking at it, I guess  I struggle - I think it's                                                                    
     an  interpretive issue  right  now. I  don't know  that                                                                    
     it's clearly defined in here.                                                                                              
                                                                                                                                
SENATOR DYSON  said the  intent of  HB 61 is  to give  credit for                                                               
expenditures that lead to production.                                                                                           
                                                                                                                                
MR. BARNES agreed.                                                                                                              
                                                                                                                                
SENATOR DYSON  stated, "If  I may,  and this  is back  to Senator                                                               
Lincoln, I think  what she was getting at, the  intention is here                                                               
that you get credit for expenditures that lead to production."                                                                  
                                                                                                                                
MR. BARNES said that is correct.                                                                                                
                                                                                                                                
SENATOR DYSON continued:                                                                                                        
                                                                                                                                
     I want it on the record  that it is my understanding of                                                                    
     what you said that all  expenditures that don't lead to                                                                    
     production, you would  not get a tax credit  for and if                                                                    
     we  ended up  with an  interpretation here  or a  court                                                                    
     case in the  future, that certainly would  be the basis                                                                    
     on which I'm going to vote for your bill.                                                                                  
                                                                                                                                
MR. BARNES asked to clarify and stated:                                                                                         
                                                                                                                                
     Just  trying to  scan through  my recollection  of this                                                                    
     bill and  then answer the  questions as they come  up -                                                                    
     in actuality,  on page 3  of [CSHB 61(FIN)-  Version S]                                                                    
     that you should  have in front of you,  line 25 through                                                                    
     about 27  probably aligns with Senator  Dyson's comment                                                                    
     that it  says, 'for real property  or tangible personal                                                                    
     property  used in  this state  in  the exploration  and                                                                    
     development  of gas  reserves in  a gas  reservoir....'                                                                    
     So, 'and  development' would  imply that  it's probably                                                                    
     only the  successful wells  so I  would imagine  that -                                                                    
     and  again  perhaps  the Department  of  Revenue  might                                                                    
     comment but  if I  were in their  shoes those  would be                                                                    
     comments  - would  line up  with your  words, so  maybe                                                                    
     it's not so silent.                                                                                                        
                                                                                                                                
SENATOR LINCOLN  said she reads  that language to mean  a company                                                               
would receive  the tax credit on  the total tax liability  in the                                                               
state, regardless  of how small  the producing gas is.  She asked                                                               
for verification or clarification.                                                                                              
                                                                                                                                
MR. GRABER, DOR,  explained that the Alaska  corporate net income                                                               
tax  is not  calculated  on a  field or  reservoir  basis so  the                                                               
credit  would  apply  to  a   corporation's  overall  Alaska  tax                                                               
liability. He said that DOR could  not apply it [to a field] even                                                               
if it wanted  to because a corporation's net  income liability in                                                               
Alaska  is  based  on  a  percentage  of  its  profits  from  its                                                               
worldwide operations.                                                                                                           
                                                                                                                                
CHAIR OGAN  referred to  the list  of write-offs  on page  4, and                                                               
asked  if those  items  must  be new  or  whether  it applies  to                                                               
existing items.                                                                                                                 
                                                                                                                                
MR. GRABER said  his understanding, according to  the language on                                                               
page 2,  line 7, is that  the credit applies to  new assets first                                                               
placed in service in Alaska.                                                                                                    
                                                                                                                                
MR. BARNES continued his presentation.                                                                                          
                                                                                                                                
   · HB 61 is needed because Alaska does not have much                                                                          
     exploration and production activity  compared to other areas                                                               
     in the  world. Natural  gas reserves in  the Cook  Inlet are                                                               
     continuing to decline. He referred  to a chart of Cook Inlet                                                               
     proven  gas  reserves  for  the   last  13  years  from  the                                                               
     Department of  Natural Resources (DNR) and  said that proven                                                               
     reserves are  defined as those  reserves in the  ground that                                                               
     have the  highest confidence with enough  supporting data to                                                               
     book  those reserves  through  the  Securities and  Exchange                                                               
     Commission. In 1990, there was about  3500 bcf of gas in the                                                               
     Cook Inlet basin. From 1995  to 1997, the reserves increased                                                               
     but  only   due  to  a   recalculation  based  on   data  on                                                               
     performance    on    existing   reservoirs.    After    that                                                               
     recalculation was  done, the  reserves continued  to decline                                                               
     to 2000 bcf last year.                                                                                                     
   · Deliverability is the rate at which gas can be produced. A                                                                 
     chart on  slide 7  compares supply and  demand for  the Cook                                                               
     Inlet  gas production.  In 1997,  Cook  Inlet could  produce                                                               
     about  900 mcf  per day  -  a world-class  volume. By  2003,                                                               
     production declined to  663 mcf per day. The  demand is just                                                               
     over 800 mcf per day so there is now a shortfall.                                                                          
   · Supply and demand rationalization is occurring due to the                                                                  
     fact  there  is  not  enough  gas  to  feed  the  low  price                                                               
     consumer.  The gas  price is  increasing,  which has  caused                                                               
     further issues with industrial consumers.                                                                                  
                                                                                                                                
SENATOR DYSON asked for the definition of WACOG.                                                                                
                                                                                                                                
MR.  BARNES  explained  WACOG  is an  acronym  for  the  weighted                                                               
average cost of  gas. That is the average price  that Enstar pays                                                               
to purchase  gas from  producers. Right now,  the WACOG  is about                                                               
$2.55 per  mcf. The Henry  Hub price is  a mark-up price  for the                                                               
Lower  48 gas  markets. That  price fluctuates;  recently it  was                                                               
$9.00 per  mcf. He  said that Enstar  has contracted  to purchase                                                               
gas  with a  floor of  $2.75 with  an upside  price of  a rolling                                                               
average. He assumes other contracts  will reflect that same price                                                               
regime.                                                                                                                         
                                                                                                                                
SENATOR DYSON asked  if some customers were unable to  get gas in                                                               
2003 because of the shortfall.                                                                                                  
                                                                                                                                
MR. BARNES said in 2003  there were industrial curtailments.  The                                                               
average consumer comes first and  then there is a hierarchy based                                                               
on price and contracts for utilities.                                                                                           
                                                                                                                                
SENATOR DYSON asked who did not get gas.                                                                                        
                                                                                                                                
MR. BARNES replied, "Agrium."                                                                                                   
                                                                                                                                
CHAIR OGAN asked if LNG is tied to the Henry Hub.                                                                               
                                                                                                                                
MR. BARNES replied:                                                                                                             
                                                                                                                                
     LNG  is tied  to a  landed  price in  Japan. There's  a                                                                    
     contract there.  And then there's  the State  of Alaska                                                                    
     royalty formula  that calculates the netback  for which                                                                    
     royalties are paid. So the  LNG does fluctuate based on                                                                    
     a world market price scenario - not Henry Hub though.                                                                      
                                                                                                                                
CHAIR  OGAN asked  if the  rough split  of who  gets what  gas is                                                               
about one-third LNG, one-third Agrium, and one-third consumer.                                                                  
                                                                                                                                
MR. BARNES said that is a rough approximation.                                                                                  
                                                                                                                                
CHAIR  OGAN  asked if  the  consumer  price  is about  $2.55  and                                                               
everyone else's price is lower.                                                                                                 
                                                                                                                                
MR.  BARNES said  that is  correct and  is a  function of  legacy                                                               
contracts. He explained the Cook  Inlet has a family of contracts                                                               
in place. When  there was an oversupply of gas  20 years ago, gas                                                               
was  signed for  long-term commitments  at very  low prices.  The                                                               
industrials, Enstar  and Chugach Electric signed  some contracts.                                                               
Supply and  demand has shifted.  There is a contract  opening and                                                               
Enstar  has   an  unmet  requirement  that   was  not  previously                                                               
contracted.   They  are   signing   incremental  contracts   and,                                                               
reflective  of  price conditions,  new  contracts  are at  higher                                                               
prices.                                                                                                                         
                                                                                                                                
SENATOR  LINCOLN referred  to  the supply  and  demand chart  and                                                               
commented  that  she expected  to  see  a fluctuation  in  demand                                                               
during the  time period from 1997  to 2003. She asked  why demand                                                               
remained consistent over six years.                                                                                             
                                                                                                                                
MR. BARNES said that represents  the peak requirement that occurs                                                               
on the  coldest day  of the  year. That  is when  Enstar, Chugach                                                               
Electric   and  the   industrials   take   their  maximum   daily                                                               
requirements. He said there has been  a small amount of growth in                                                               
the Anchorage  economy. Enstar typically  forecasts about 1  to 2                                                               
percent growth  per year. The average  demand is going up  but it                                                               
peaks  seasonally   so  the  total   requirement  on   the  graph                                                               
represents what happened on the coldest day of the year.                                                                        
                                                                                                                                
CHAIR  OGAN noted  other areas  of the  country warehouse  gas to                                                               
meet peak demands but no one is doing that in Alaska.                                                                           
                                                                                                                                
MR.  BARNES said  no  one currently  has  gas storage  available,                                                               
although that possibility has been discussed.                                                                                   
                                                                                                                                
He then continued with his presentation.                                                                                        
                                                                                                                                
   · The current proven reserves in Cook Inlet are 2000 bcf,                                                                    
     with a 10-year production life  that will decline over time.                                                               
     Market forces will affect rate  declines but, on an absolute                                                               
     basis, the  production life is  typically represented  as 10                                                               
     years. Various  government entities and private  groups have                                                               
     estimated  the  probable  reserves   at  1050  bcf  and  the                                                               
     possible  reserves  at  2100  bcf.  The  chance  of  finding                                                               
     probable reserves  is less  than 50  percent; the  chance of                                                               
     finding possible  reserves is  less than  10 or  20 percent.                                                               
     Therefore, a potential opportunity of 3150 bcf exists.                                                                     
                                                                                                                                
CHAIR OGAN asked who provided those figures.                                                                                    
                                                                                                                                
MR. BARNES said  the Potential Gas Committee,  an industry group,                                                               
provided  the  numbers.  That  committee  looks  at  natural  gas                                                               
resources  across various  basins  in the  United  States; it  is                                                               
funded  by private  and public  dollars. The  Minerals Management                                                               
Service has done other studies.  The numbers typically range from                                                               
1000  to  3000  bcf.  He   believes  that  number  excludes  non-                                                               
conventional  resources,  such  as  coal  bed  methane  or  other                                                               
alternatives  that may  be  there.  He said  he  does not  recall                                                               
seeing any numbers from DNR.                                                                                                    
                                                                                                                                
CHAIR OGAN  asked if  there are any  bookable proven  reserves at                                                               
this point.                                                                                                                     
                                                                                                                                
MR. BARNES said there are not. He then continued.                                                                               
                                                                                                                                
   · Regarding the impacts of HB 61 on the State of Alaska, it                                                                  
     should stimulate Cook Inlet and  other basin exploration. It                                                               
     will  aid  in  maintaining  the  Cook  Inlet  200+  bcf/year                                                               
     production, the  equivalent of a  13th month of  North Slope                                                               
     production.  He  said the  state  is  proud of  North  Slope                                                               
     production  but  should also  be  proud  of Cook  Inlet  gas                                                               
     production.  HB 61  should provide  gas for  the Cook  Inlet                                                               
     utilities, industrials, jobs, royalties, and taxes.                                                                        
   · Marathon believes the fiscal impact to the State of Alaska                                                                 
     will  be positive.  Both  fiscal notes  show  a zero  fiscal                                                               
     impact but discuss the difficulty  of estimating the outcome                                                               
     of discoveries. Some  of the factors that  make the positive                                                               
     impact difficult to estimate are  the number of developments                                                               
     that will be "incentivized," what  new work will happen, how                                                               
     much  gas will  be discovered,  the royalty  value, and  how                                                               
     much will be spent for exploration and development.                                                                        
   · The table entitled Fiscal Impact to State of Alaska is                                                                   
     based  on the  following  assumptions: a  varied field  size                                                               
     from zero to 500 bcf, development  cost of 50 cents per mcf,                                                               
     royalty at  12.5 percent, severance  tax at 7.5  percent, ad                                                               
     valorem tax at  2.7 percent, and a gas sales  price at $2.50                                                               
     per mcf.  For example, if an  operator were to find  a field                                                               
     size of 50 bcf, the  operator would spend about $25 million.                                                               
     The  tax credit  would  amount to  $2.5  million. The  gross                                                               
     revenue to  the state  would be $125  million. Royalty  on a                                                               
     state lease at  12.5 percent would equal  $15.6 million. The                                                               
     severance tax  at 7.5 percent  would equal $9.3  million and                                                               
     the ad  valorem tax  would amount to  about $1  million. The                                                               
     total  tax  take  would equal  $26  million.  Therefore,  an                                                               
     operator would spend  $25 million to find,  develop and sell                                                               
     gas. That  operator is eligible  for a $2.5  million credit.                                                               
     The state  would ultimately receive $26  million. Therefore,                                                               
     $25 million  was originally  invested in  the state  and $26                                                               
     million is received later.                                                                                                 
                                                                                                                                
MR.  BARNES said  based on  his  conceptual model,  the State  of                                                               
Alaska could  receive from  $3 to $10  of additional  revenue for                                                               
each $1 of tax  credit. The $3 amount is the  lowest amount for a                                                               
discovery not  on state  leased property.  The state  would still                                                               
receive  severance tax  and other  funds. Marathon  believes this                                                               
credit  is needed  now. There  is not  enough exploration  in the                                                               
Cook Inlet right now to meet  demand. If the Cook Inlet burns 200                                                               
bcf per year at 50 cents per  mcf, at least $100 million per year                                                               
needs to be consistently spent  on natural gas development. A lot                                                               
of money is spent on offshore  oil operations in the Inlet. Other                                                               
areas  of  the state  would  also  benefit from  exploration  and                                                               
development,  for   example  the   Nenana  Basin.   Finally,  new                                                               
discoveries take about 3 to 5 years to bring gas to market.                                                                     
                                                                                                                                
MR. BARNES told members that to  measure whether HB 61 has been a                                                               
success, the  state should  look to  see whether  lease activity,                                                               
drilling   activity,   construction   activity   and   production                                                               
increased.  The credits  apply to  income tax  so they  will only                                                               
apply to  companies already in  business and paying taxes  in the                                                               
state. He  repeated that  for every  $1 spent  by the  state, $10                                                               
will be spent to find and develop new reserves.                                                                                 
                                                                                                                                
CHAIR OGAN asked Mr. Barnes  to suggest a timeframe for measuring                                                               
success.                                                                                                                        
                                                                                                                                
MR. BARNES said it will take  time for industry to react. He said                                                               
if a  company already has  a lease, the  company will have  to do                                                               
seismic  testing.  Then it  will  have  to progress  the  project                                                               
through the corporation to get  it funded. He said most companies                                                               
are  now   multinational;  projects  are  judged   against  other                                                               
worldwide  investment opportunities.  He  hoped  the state  would                                                               
begin  to see  early indicators  in the  next year  or two.  Some                                                               
companies  are already  exploring but  not on  a high,  sustained                                                               
level. He  said he hopes,  after three  to five years,  the state                                                               
could see increased activity.                                                                                                   
                                                                                                                                
CHAIR OGAN  said he has  considered adding a sunset  provision to                                                               
the  bill  to  require  the legislature  to  review  whether  the                                                               
program has been successful.                                                                                                    
                                                                                                                                
MR. BARNES  said 10  years equals about  two to  three investment                                                               
cycles for a  company. He said if no activity  is occurring after                                                               
five years,  the state might  review whether this is  the correct                                                               
incentive  to use.  Marathon  believes a  10-year  cycle is  best                                                               
because it  takes three  years from discovery  to first  gas, and                                                               
the lease work,  seismic, and permit approvals take  a few years.                                                               
He believes five years would not be long enough.                                                                                
                                                                                                                                
SENATOR BEN  STEVENS said the committee  was provided information                                                               
about collective  ownership of various  fields in Cook  Inlet. He                                                               
noted that Marathon  owns 100 percent of several fields  and is a                                                               
partner in  a few multiple  and joint ownership fields.  He asked                                                               
how  the tax  credit  would be  delineated  when multiple  owners                                                               
invest in a field.                                                                                                              
                                                                                                                                
MR. BARNES explained that most  field productions are not held in                                                               
limited  liability  corporations.  They  operate  under  a  joint                                                               
operating agreement  controlled by  the State  of Alaska  in most                                                               
cases.  In that  agreement, ownership  is defined  by percentage.                                                               
Funds  are invested  along those  percentages, earnings  are made                                                               
along those  percentages and then  royalty is paid. In  this type                                                               
of  an ownership  model, companies  would pay  taxes individually                                                               
and invest individually.  They know how much money  they spent in                                                               
a field that would qualify.                                                                                                     
                                                                                                                                
SENATOR BEN STEVENS asked if that  would be part of the component                                                               
mentioned in subsection  (d) on page 2, line  24, which addresses                                                               
a subscribed  form designed by  the department. He asked  if that                                                               
form exists now.                                                                                                                
                                                                                                                                
MR. LOGSDON  said documentation of the  joint operating agreement                                                               
would  substantiate the  amount of  the investment.  Whether that                                                               
would be concluded in the form is something DOR would examine.                                                                  
                                                                                                                                
SENATOR  BEN  STEVENS asked  if  Mr.  Logsdon's office  would  be                                                               
developing that form.                                                                                                           
                                                                                                                                
MR. LOGSDON said it would.  DOR will develop this form associated                                                               
with this tax credit for inclusion with the tax return.                                                                         
                                                                                                                                
SENATOR  BEN   STEVENS  asked  if  DOR   approves  the  operating                                                               
agreements.                                                                                                                     
                                                                                                                                
MR.  LOGSDON said  DNR would  approve  the operating  agreements,                                                               
which  would  also   be  subject  to  the  Alaska   Oil  and  Gas                                                               
Conservation   Commission's   technical   production   compliance                                                               
requirements.                                                                                                                   
                                                                                                                                
CHAIR OGAN  thanked Mr.  Barnes.   He then  asked Mr.  Logsdon to                                                               
brief the committee on DOR's fiscal note.                                                                                       
                                                                                                                                
MR.  LOGSDON  stated  the  Administration  neither  supports  nor                                                               
opposes the  bill. DOR prepared  a fiscal note because  there are                                                               
some uncertainties. He pointed out that  HB 61 is not exactly the                                                               
same as  the federal investment tax  credit but it provides  a 10                                                               
percent credit on qualified capital  investment. It also includes                                                               
qualified services,  which are defined  in the bill. He  said one                                                               
question  that was  addressed  in  the fiscal  note  is that  the                                                               
corporate  income tax  liability in  the State  of Alaska  is not                                                               
specific to an apportioned amount  of federal net income. He said                                                               
the main uncertainty is the number  of credits that will be taken                                                               
and to what  extent market forces alone will  affect activity. In                                                               
balancing the two, DOR elected to calculate a zero fiscal note.                                                                 
                                                                                                                                
CHAIR  OGAN cited  the last  two  sentences in  the fiscal  note,                                                               
which reads,  "A risk  to the  state is high  if gas  prices spur                                                               
development on their own regardless  of the tax credit. The state                                                               
could be  in the position  of providing a  tax credit that  is no                                                               
longer necessary  to promote  development." He  asked if  DOR has                                                               
had an  opportunity to review  the models provided by  Mr. Barnes                                                               
in which the state would receive $10 for every $1 spent.                                                                        
                                                                                                                                
MR. LOGSDON said he has and  that Mr. Barnes' calculations of the                                                               
potential benefits are correct. His  point was that the only real                                                               
risk, which  applies to  any tax  credit, is  that the  amount of                                                               
activity attributed to the incentives  might have happened anyway                                                               
due to market forces.                                                                                                           
                                                                                                                                
SENATOR  LINCOLN  said,  in  her  mind,  a  neutral  position  on                                                               
legislation  implies problems  with the  bill. She  asked if  the                                                               
Chair plans to hold the bill in committee.                                                                                      
                                                                                                                                
CHAIR OGAN said he  plans to recess to the call  of the Chair and                                                               
let  members  consider  the  legislation  over  night.  He  asked                                                               
members to consider placing a  sunset provision in the bill based                                                               
on the department's fiscal note. He  said he would rather let the                                                               
market drive  development. He pointed  out that  artificially low                                                               
prices on  contracts are  affecting the  Cook Inlet  market right                                                               
now. He  believes the Regulatory  Commission's action to  tie the                                                               
price to the Henry Hub was helpful.                                                                                             
                                                                                                                                
In  response to  Senator Lincoln's  comment, SENATOR  BEN STEVENS                                                               
said his  position is that  CSHB 61(FIN)  is a major  policy call                                                               
for  the legislature  to make,  not the  implementers. He  thinks                                                               
this  policy call  should  be  based on  whether  it will  create                                                               
incentives  for  investment. To  do  that,  the legislature  must                                                               
weigh  the positives  and  negatives of  the  incentive. It  will                                                               
provide a 10  percent credit against the investment  cost only to                                                               
an  investment   that  will  generate  revenue.   Therefore,  the                                                               
positive of the incentive is that  it creates a royalty stream, a                                                               
severance tax,  and additional property  tax. The  incentive will                                                               
only be provided if a company produces revenue.                                                                                 
                                                                                                                                
TAPE 03-43, SIDE A                                                                                                            
                                                                                                                                
SENATOR BEN  STEVENS said  he strongly  supports movement  of the                                                               
bill. He views the fiscal note as indeterminate on the up side.                                                                 
                                                                                                                                
CHAIR  OGAN  said he  too  supports  investment tax  credits.  He                                                               
decided  to  expand his  own  business  based  on a  federal  tax                                                               
credit. He  supports this  legislation and would  like to  see it                                                               
pass as  soon as possible.  He then  recessed the meeting  to the                                                               
call of the Chair at 5:17 p.m.                                                                                                  

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