Legislature(2007 - 2008)BUTROVICH 205
10/25/2007 10:00 AM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| SB2001 | |
| Roundtable | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB2001 | TELECONFERENCED | |
SB2001-OIL & GAS TAX AMENDMENTS
CHAIR HUGGINS announced the consideration of SB 2001.
WAYNE STEVENS, President and CEO, Alaska State Chamber of
Commerce, Juneau, Alaska, said the Chamber is concerned about
the proposed changes to the recently enacted petroleum
production tax embodied in ACES. The Chamber believes changing
the tax structure so quickly will have long-term negative
impacts on the future of Alaska's economy. They also believe the
consequences of adopting ACES have not been fully considered
with regard to all business in Alaska.
He said the Chamber is a business advocacy organization whose
mission is to drive positive change for Alaska's business
environment and to improve its member organizations by providing
leadership, advocacy and support. The State Chamber members have
a strong commitment to ethical business conduct and understand
the legislature's commitment to ethical conduct among elected
and public officials. Because the legislators have heard from
Alaskans' that their faith in the current PPT is shaken, they
understand the desire to review it again. However, they also
believe this comes with great risk.
MR. STEVENS said they urged caution in the rush to find a fix
for something that is not broken. The concern is that while the
governor and legislature work to restore public faith, outcomes
based more on emotion than economics will further chill the oil
investment climate.
He said a second concern is the stated goal of generating more
revenue for the treasury, but Chamber members fear that Alaskans
will confuse the outcome of higher tax revenue with the goal of
fair share. Members believe tax debate creates unwelcome risk
and stalls investment planning and decisions. Taxes are a key
consideration in all business decisions and anytime tax law is
debated, investments can be delayed; the wrong tax rate can end
all consideration of investment. He said that working to induce
investment such as the pipeline full of oil at $80 plus per
barrel would generate more revenue at the current tax rate than
would a dwindling quantity of oil at a higher tax rate.
Most members of the Chamber do not understand the finer details
of petroleum exploration and production. However they all
understand two major trends in Alaska's oil patch. Taxes on the
oil industry have increased at a rate no other business segment
could survive. But despite billions of dollars invested by the
oil industry on the North Slope and Cook Inlet, production
continues to decline at an alarming rate. Many have noted this
decline and think that proposing a new increase to the
production tax is a risky policy given the desire to encourage
increased production.
He said that a decade-old tax regime in Cook Inlet is
encouraging very limited investment and recent investments on
the North Slope were committed under the significantly lower
economic limit factor tax (ELF) and historically high oil
prices. Yet this exploration activity pales in comparison to
that taking place in Canada and the Gulf of Mexico. He stated
that raising production taxes in light of limited investment is
counter intuitive. Instead of referring to fiscal notes and
revenue projections, he urged them to set the policy outcomes
they desire in the oil patch and then debate language to achieve
those outcomes. He suggested: "Adopt an oil tax regime that will
generate reasonable revenue for state government while
encouraging maximum utilization of oil reserves."
He said the State Chamber had advocated for decades for a state
fiscal plan and willingness to check spending. A clear plan
however is not guiding spending or revenue collection or the
question of how the state can invest new revenue in projects
that will render a return on investment. Given today's oil
prices, the taxes the ACES proposes to collect go to revenue for
a fiscal system that results in increased spending, but lacks a
strategic business plan for the state. This policy outcome does
not warrant worsening the investment environment.
He said the State Chamber members have a strong commitment to
ethical business conduct and this includes many members from the
oil and gas industry. Given the daily headlines and
investigations their concern is that many Alaskans now view
business negatively. This impression is further fueled by the
implication that the oil and gas industry has somehow slighted
the state through its accounting practices. He encouraged them
to consider this dynamic and to avoid making unfair accusations
that fuel this distrust.
He said at the end of the day differences of opinions exist and
reasonable people can disagree. He offered the Chamber's
assistance in boosting the state tax audit capabilities saying
they are confident that if industry can hire talent to
administer a wide range of complex tax regimes throughout the
world, Alaska can recruit the best and brightest to administer
its single tax regime. This expertise he said would be found in
a combination of state employees and private contractors.
Although they are concerned with the proposed minimum tax on
certain fields, they thanked the legislature for recognizing the
wisdom of a profits tax. He commented, "So many today
illogically condemn petroleum industry profits. Alaskans should
cheer since those profits will allow the same companies to make
the world class investments Alaska needs to monetize our oil and
gas."
10:19:13 AM
SENATOR WIELECHOWSKI said he is glad Mr. Stevens brought up the
idea of profits, because all the oil companies have made huge
profits. However, he said, they are not spending these profits
increasingly in Alaska, but rather giving it back to their
investors. He wanted to encourage them to explore in Alaska with
more of their profits because there are global shortages of both
oil and gas. He asked how the Chamber thinks the producers could
be encouraged to develop the fields on the North Slope that are
profitable because they are not doing it now.
10:20:49 AM
MR. STEVENS responded that in looking at the one line item of
billions in profit, you lose perspective of the costs and how
they relate to each other. He thought it was important to focus
on an overall balance sheet - the percentages of income,
expense, assets, liabilities, equities et cetera - so that they
don't stray too far away from what other industries like banking
and national retail industries fall under.
He stated that Alaska is a significant shareholder and on one
hand it slaps the industry around and tries to get more revenue
from them; yet the managers of our investment funds - retirement
funds or the Permanent Fund - if they didn't reach a certain
level of return on investment from those holds, would be selling
them off with vigor because they weren't producing the kinds of
returns they want and that the citizens of Alaska share in as a
part of their dividend. Isolating a single item or shareholders
without acknowledging that the state is a shareholder with a
significant portion of its portfolio invested in the oil
industry is not the right thing to do. However, the PPT was
designed with this premise.
10:22:56 AM
SENATOR WAGONER said they have heard over and over again that
Alaska has the highest oil tax regime in North America, but he
doesn't buy into it. His studies have shown him that Alberta has
a 25 percent royalty - 24 percent of which is forgiven until the
companies recoup their investment costs - then it goes back to
25 percent - in addition to other taxes. Alberta is now looking
at revamping its tax structure and their head advisor was Dr.
Pedro van Meurs. They are now looking at a three-tier tax
structure for oil, gas and oil sands. The figure he saw was
taxing the oil sands at 33 percent royalty. With figures like
that, he didn't think Alaska was the higher of the tax regimes.
Everyone else in the world is changing their tax structure to
take what they see as more of a fair proportion of the revenues
from their resource. He said he used to be a retailer, so he
understood where the Chamber was coming from, but he still
thinks the state needs to take its equitable portion.
10:25:05 AM
MR. STEVENS responded that he reads a lot of different numbers
and depending on how they are portrayed, Alaska ends up in the
higher end of comparable tax regimes. What doesn't get talked
about is the higher cost of doing business on the North Slope of
Alaska versus Alberta and the cost of an 800-mile transportation
system to get to tidewater that Alberta or other Gulf of Mexico
entities don't have. It is difficult to compare them with Alaska
without filling in the complete picture. He thinks it is good to
review the tax structure as a business person would to make sure
it is right. They need to keep the pipeline full. It is designed
for 2.1 million/barrels a day and it is only using a third of
that capacity with a 6 to 12 percent annual decline. It doesn't
take very long to work the math down to get to that point where
it is not feasible to run the pipeline. That window of time
diminishing before a gasline starts that would increase some of
that production is "pretty scary."
10:27:30 AM
SENATOR WAGONER cautioned:
Don't get too scared about that, because a lot of the
information being put out that that pipeline won't be
operational at 300,000 barrels/day is pure just
information that is not factual. Because all they have
to do is change the mechanical makeup of that pipeline
and it can carry 300,000 barrels/day through chokes
and changes and pumping systems and things like that.
He said people in the oil industry have assured him that that is
not a consideration at this time, but it's being made a
consideration in several presentations.
CHAIR HUGGINS commented that he saw it as their task to avoid
seeking the answer to that.
SENATOR STEVENS summarized Mr. Stevens' comments that we haven't
really given PPT a chance and we don't really know the answers
yet and don't have the data to decide whether it's the right or
wrong approach. He was saying to give it a little more time to
see if it works or not.
MR. STEVENS responded that was correct.
10:29:54 AM
SENATOR WAGONER offered him a copy of the Alberta proposal.
SENATOR STEDMAN said the last round on the PPT discussions spent
quite a bit of time comparing oil basins and the difference
between oil and gas and other production. What we are dealing
with is a natural life-cycle of an oil basin where it peaks, in
this case, at 2 million barrels/day and now is substantially
below that at less than 50 percent. What they are trying to do
is extend the lifecycle. He didn't want the people at home to
think that if they create the magic combination of taxes and
incentives that would bring production back up to 2 million
barrels per day. The odds of that happening are near zero unless
they find another Prudhoe Bay.
MR. STEVENS agreed and added that the oil industry would like to
move east from Prudhoe Bay where there may be some opportunity
for that, but it has restrictions on it. Offshore has other
restrictions and other considerations that drive up costs and
restrict access. They should try to strike that balance of an
appropriate tax structure that encourages people to take the
risk. He remembered that the producer at Milne Point spent a
year exploring and found nothing but a dry hole. "Any good
business person would try to balance risk and reward."
CHAIR HUGGINS said the one thing he liked about what Alberta has
done which Alaska is not doing is taking the time to come up
with a solution. This is a special session and they have only 30
days. He said even the administration had to contract with an
outside contractor to write the bill because people were doing
other things. Alberta has a very deliberate process over a time
span to look at the ramifications of what they are being asked
to do. He admonished:
Good for them and shame on us, because we're doing
just the opposite. We're essentially saying - bring
those guys to Juneau, give 'em 30 days and we want an
answer. My concern about that is the validity of what
we do and the durability of the results. And we know
there's going to be a gas pipeline proposition that's
going to ask us to look at gas. And my concern is the
timeframe that we're being asked to answer the
questions will not allow us to get to the questions
that will stand the test of time.
CHAIR HUGGINS said he is concerned about the direction Alaska's
economy is heading and it is an understatement to say Alaska's
real estate market is soft. Agrium with its 100-plus jobs has
closed its doors, and in Palmer, the administration is helping
Matanuska Maid to close its doors. He knows that Alaska has a
power generation challenge and Enstar has difficulty in getting
natural gas. The dynamics of things that are coming together
about the state's economy are concerning to him along with state
spending habits - whether they like it or not, the Public
Employees Retirement system is looking for $8 billion to $10
billion. He asked Mr. Stevens if he should be concerned from the
State Chamber's perspective or not because of the magnitude of
the assets the state has.
10:35:23 AM
MR. STEVENS responded, "You should be very concerned." There are
a number of very troubling trends. Alaska has enjoyed a largess
from a number of sources like federal funding that is coming to
an end in the near future. Alaska has tremendous fish, mineral,
oil and gas resources at its disposal and at every turn business
is thwarted by those who don't want to allow the state to
develop them. The tourist industry seems to be strong, but that
can change at a moment's notice. He said the state is facing a
number of issues including where its future employees will come
from. People are reaching retirement age, but there is no
mechanism to keep young people in Alaska or encourage them to
avail themselves of vocational opportunities. He said Alaska has
done little about it.
MR. STEVENS said there is no fiscal plan and the state doesn't
have a common goal; it has created a system that pays everyone
to just be here and that payment is going to increase; yet we're
not attracting businesses that challenge us to create an economy
beyond government and distribution of common wealth. "And that's
troubling. That's very troubling."
10:38:58 AM
KEN THOMPSON, Managing Director, Brooks Range Petroleum,
Anchorage Alaska, read the following testimony [this is not
verbatim, however]:
I am the Managing Director for Alaska Venture Capital
Group, or AVCG LLC, an independent oil exploration
company formed with a sole focus on the North Slope of
Alaska. AVCG is a privately held member LLC comprised
of private equity investors made up of 15 independent
oil and gas companies and individuals from Kansas and
me as an owner/member partner from Alaska. AVCG has a
technical and operational services' subsidiary company
called Brooks Range Petroleum, with offices and staff
in Anchorage. In Alaska and on the North Slope, we
operate under the name Brooks Range Petroleum.
AVCG has lease holdings and explores currently only in
Alaska…and nowhere else. AVCG/Brooks Range Petroleum
likes to think of our company as 'Alaska's Independent
Oil and Gas Company.'
AVCG LLC has been very active in the past seven North
Slope areawide lease sales and active in acquiring
acreage held by other companies where we see
potential. We and our partners currently hold over
300,000 acres of exploration leases in five
exploration prospect areas on the Slope. Our
exploration strategy is to explore in the central part
of the North Slope for fields in the 10-100+ million
barrels range, fields that may be too small for the
giant producers but satisfy as niche fields that can
be 'company makers' for a small independent. We
believe there are hundreds of millions if not billions
of barrels of oil left on the central North Slope in
smaller fields of this size for small independents
like ours that want to take this type of exploration
risk.
Last year, AVCG LLC announced joint venture agreements
with two Canadian independents, TG World Energy and
Bow Valley Energy, and with a private exploration
company from Houston, Ramshorn Exploration. Together,
as working interest co-owners we are exploring the
central part of the North Slope.
In the winter of 2006, AVCG participated with an
ownership interest in the Cronus exploration well
about 10 miles southwest of the Kuparuk Field,
operated by Pioneer Natural Resources. Unfortunately,
that well was a dry hole.
This past winter for the first time, our operations
subsidiary, Brooks Range Petroleum, operated the
drilling of two exploration wells for our working
interest partners in the Gwydyr Bay area of the North
Slope, just northwest of Prudhoe Bay. One well, the
Sak River #1, was a dry hole, but we were excited to
announce earlier this year that our Northshore #1 well
northwest of the Prudhoe Bay Field did strike oil. We
plan to complete and test this well this winter. In
addition, we ran a 130-square mile 3D seismic survey
over our acreage and surrounding area in the Gwydyr
Bay area on the North Slope. In total this past
drilling season, our JV Group invested over $44
million on land, seismic and drilling activities.
This winter our Joint Venture Group will be among the
most active of explorers as we plan to shoot over 200
square miles of new seismic data on the extreme
western and eastern sides of the Central North Slope
and to drill up to four exploration wells. We plan to
test the Northshore #1 well and also drill one or two
other exploration wells nearby to see if we can
discover a sufficient volume of oil to warrant a
commercial development at Gywdyr Bay. We will drill
our Tofkat #1 well south of the Alpine Field and also
drill a fourth exploration well on a prospect to be
named. In total, our group will spend over $40 million
in seismic and exploratory drilling in winter 2008. If
our Northshore oil completion test is as suspected and
one of the wells strikes oil close by, we may proceed
with Northshore development with more substantial
capital investment in the second half of 2008.
My comments today represent the perspectives of a
small, independent exploration company that is
actively exploring on the North Slope with a good
level of activity, generally on prospects that because
of smaller size no longer interests the major
companies. At the end of next drilling season, AVCG
since 1999 and our partners since last year will have
jointly invested over $100 million in Alaska even
though none in our group have generated any revenues
yet from Alaska oil, so we sincerely appreciate being
listened to. We think in the long run we can bring
substantial, incremental value to the State of Alaska.
Please wish us good luck.
Many of you also know me as the past President of ARCO
Alaska, Inc. from 1994-1998. I also served as
Executive Vice-President for ARCO and head of global
oil and gas exploration for ARCO. I do have
exploration and production experience in 10 U.S.
states and in over 20 countries throughout the world,
so I'll also share my perspective in how I see the
ACES bill in the context of competitiveness in the
United States and in the world.
General Comments on ACES Legislation
At this point, I would like to address various key
points in the ACES legislation. First, our company
prefers that the PPT be allowed to run its course in
the next few years, and that ACES not be approved with
its current provisions. I agree with Dr. Pedro van
Meurs that in the light of declining oil production in
the state of Alaska and prospectivity trending to
smaller field sizes, the State should not once again
increase its taxes after having done so last year. I
will tell you that when recruiting companies to join
in our Alaska ventures in 2005 and 2006, many were
concerned about the threat of tax increases in Alaska.
PPT proved tax increases were not a threat but a
reality. Adding yet another tax increase via the ACES
bill this year shows instability in Alaska's tax
policy which results in uncertainty and risk when
making investment decisions.
I heard that consultant Daniel Johnston differed
strongly from Dr. van Meurs and urged the oil industry
to understand the "cloud of corruption" over the
existing Petroleum Profits Tax, or PPT, and that this
alone provides a good reason to change PPT. I
challenge Daniel Johnston that the bushel should not
be thrown but because of a few bad apples.
10:49:31 AM
In fact, last year during the PPT debates, I recall
those who are guilty of paying bribes and some who are
accused of taking bribes actually supported a 20
percent base tax rate, not the 22.5 percent base rate
that was finally adopted. In fact, I'd like to think
that the almost all in the legislature and in industry
were honest, that they could be trusted in their
deliberations last year, and that the final answer of
PPT was a good answer and an honorable answer.
It is also very important to keep in mind that the
progressivity tax was added at high oil prices to
drive the real tax rate to even higher levels than
22.5 percent, with a range exceeding 30percent now
possible at certain prices. And let's not forget to
tack on the royalty, the corporate tax, the ad valorem
property tax, and environmental and permitting fees.
It appeared to me that the checks and balances in the
system worked in the Legislature last year, and I
applaud the honesty of the legislators who in the end
made a positive difference.
But I sit here feeling as if the honest and
trustworthy investors in this industry are being
punished alongside the guilty. I personally think this
will have negative consequences for Alaska in the long
haul in relationships and even in sustainable
increased value. I am politically astute enough to
know that the ACES train is moving fast down the
track, so I can stand out of the way or jump on board
and try to make the ACES bill better before we reach
derailment in the long-term relationships between this
industry I love and this State I love. So, I have some
suggestions of things not to change and things to
change in the ACES proposal.
10:50:38 AM
1) Keep the exploration and development investment tax
credits. For a small explorer startup company like
AVCG LLC, the exploration economics with the
exploration tax credits ranging from 20-40 percent as
provided by PPT and with ACES are more favorable with
an improvement in the investor's rate of return as
compared with Alaska's old severance tax system.
Near-term cash flow because of the investment tax
credits is higher which improves the return on
investment. Plus refund of cash to companies like AVCG
and our working interest partners via the credits mean
that we can apply that cash to our capital budget the
next year to run adequate seismic and do additional
drilling that increases the chance of more oil
production and reserves for us and for the State.
Likewise, the credits for losses for a startup company
like ours while we establish production - and also the
development investment credit - can take substantial
risk out of development of smaller fields that our
company is focusing on. Many of these smaller fields
can add up over time and provide significant
incremental revenue to the State.
10:52:31 AM
2) Keep the standard tax deduction/exemption for smaller
companies. The small producer tax credit that exempts
up to the first $12,000,000 in production taxes for
smaller companies can allow us to return a larger share
of our annual cash flow for exploration and investment
while we build the company to a critical mass of
reserves and production necessary to expand staffing
and have a routine level of major capital spending each
year.
10:54:46 AM
3) Keep the new ACES tax credit allowance for qualified
delineation wells. A new proposal in the ACES bill that
was not in the PPT law is the possible tax credit
allowance for the investment in up to two delineation
wells following a discovery. This would be very helpful
to small explorers as well as for large companies on
the North Slope where often one well is not enough to
determine if field size is large enough to warrant
development.
A real case in point is that should we have a
discovery this coming winter at our Tofkat exploration
well on the western side of the Slope, we will have to
drill one or two delineation wells to confirm if field
size is sufficient to develop the resource at this
remote location. Often, due to the nature of these
complex stratigraphic traps where sands unpredictably
come and go, the delineation wells can be almost as
risky as the initial exploration well. Having a credit
where the State, in a real sense, is sharing in the
risk will - I think - expedite delineation of new
fields and advance development for revenues.
4) Keep the revised progressivity tax rate at 0.2 percent
per dollar increase in oil price. The PPT tax law had
an incremental tax rate of 0.25 percent per each
dollar increase in oil price above a trigger price
while the new ACES reduces this incremental tax rate
to 0.2 percent per dollar increase in oil price at a
trigger price. While we can debate all day long the
competitiveness of Alaska's tax rate with other
countries' fiscal systems, giving some reduction in
this surcharge keeps the government take at more
reasonable levels. However, as I'll outline below, I
would change the ACES trigger price back to $40 per
barrel net and not the proposed $30 per barrel net if
Alaska wants to better balance revenues with industry
capital investment at low prices as I'll more fully
discuss.
5) Do establish the Oil and Gas Tax Credit Fund for the
purposes of purchasing certain tax credits from
explorers and producers. This ACES provision would
establish a procedure and standard for appropriation
into this fund and management of this fund. Having a
clear and transparent way for small explorers to
receive their credits at full value is extremely
important for AVCG to then be able to plow those
credits back into seismic and exploration on the North
Slope.
10:56:53 AM
6) Change the recovery of tax credits from two years as
proposed in ACES back to the recovery of credits in
one year currently provided for in the PPT law. In the
PPT law, a company could file for the various credits,
and if approved, would receive those full capital
credits not to exceed credits of $25 million per
company. In the new ACES law, while the cap has been
removed which is very positive, the credits are
refunded over two years instead of over one year; for
example, 50 percent of qualified credits can be
applied for in the first year once a well is completed
or abandoned and 50percent in the following year.
10:58:48 AM
For a small company like ours, this will definitely
affect our capital spending in a given winter as we
plow all the credit refunds back into seismic or
exploration drilling. As a very real example, AVCG and
our working interest owners are projecting to spend
$41 million in seismic and exploration drilling this
coming winter and likely around the same in 2009. We
calculate that we could receive $16 million cash in
qualified credits in mid-year 2008. So essentially,
our working interest owners are planning to provide
cash out of pocket of $25 million for the 2009
drilling season; this is a fixed number based on cash
availability in these small companies to spend toward
the Alaska portfolio. If the State refunds only one-
half of this credit in the first year, or only $8
million instead of $16 million, AVCG and our partners
will still provide $25 million out of our pockets as
now planned and budgeted…meaning our overall spending
in 2009 will be $33 million, not $41 million, i.e. $25
million from our available funds and only $8MM from
the State. This would mean one less well that will be
drilled by our group in 2009. And one less chance for
another discovery that eventually could provide
revenues to us all.
11:00:46 AM
With small companies, this is just the way our cash
flow situation works. And for some of our AVCG
investors like me, when I say "out of pocket," I mean
"out of pocket." So, we hope the full credit can be
applied for and refunded in a given year. We hope
this happens for all of industry. As an innovative
compromise, however, the legislature may consider a
small company refund provision that allows for
companies that meet the no production or low
production measures in the small company tax credit
provision of the PPT law - that remains in ACES - to
receive tax credit refunds that are fully refunded in
the first year for qualified costs. Once a company
grows in production beyond this 'small company'
measure with more substantial cash flow, perhaps
refunds of 50percent each year would apply as outlined
in ACES.
11:02:58 AM
SENATOR WAGONER asked if those credits only apply to the smaller
explorer and not much to the majors, because they have the
production to write it off against - including Chevron. When
they are talking about purchasing back the credits, they are
only talking about the smaller producers. Instead of being more
complicated, it would be simpler for the state to just buy them
back at 100 percent, because that's what it would pay anyway.
MR. THOMPSON replied that would help for Brooks particularly if
it were in one year instead of two, because that is capital that
is put back into the business. For his size program, that would
mean one more well he could drill in every winter. Major
producers can deduct the credits off their tax bill and this
would affect their capital profile, but it's just less cash flow
for them.
MR. THOMPSON continued reading his comments on the PPT tax rate:
11:04:43 AM
Change the base tax rate in ACES from 25 percent back
to the PPT tax rate of 22.5 percent, and re-review
again in 2011 after some time has passed as allowed
for in current law. As I mentioned in my introduction,
I felt the 22.5 percent base tax rate was reasonable.
And the real tax rate is much higher with the tax
progressivity factor. But what is fair, and how
exactly is 'fair' determined?
I saw a copy of a presentation entitled 'Guiding
Principles For A New Production Tax System' by the
Department of Revenue urging the changes in ACES,
arguing that the average government take in various
international countries averaged 67 percent for all
types of fiscal regimes. So that the ACES government
take, at an oil price of $60/barrel net, is 68
percent. So these principles argued that that was fair
for Alaska to take 68 percent when the international
average is 67. Somehow, the Department of Revenue
representatives concluded an average of 68 percent as
provided for in ACES would be close to the average of
67 percent for all types of regimes internationally.
11:06:45 AM
On that same slide show the DOR broke the fiscal
regimes into two types: production sharing agreements
where the government take averages 74 percent, but in
tax and royalty regimes like Alaska's, for those
international companies that had tax a royalty
regimes, the average take was 55 percent as shown by
the DOR.
11:07:27 AM
First, the average recommended to Alaska is the
average of all regimes, i.e. the averaging of
government take from tax and royalty regime countries
and government take from production sharing agreement
(PSA) regimes.
In the years I was with Arco and I managed a research
center and worked in 20 countries or so and also when
I was executive vice president and also in charge of
global exploration working in over 20 countries, I'm
very familiar with different types of production
sharing regimes, and actually the risk profile for
capital development was often much different than in
regimes that use a tax and royalty system like Alaska.
In some of the PSA countries where I worked, it was
not unusual for a producer on capital projects to have
a very low initial tax burden until the capital
investment was fully recovered plus a negotiated rate-
of-return was achieved. So we would literally get all
of our money back up front, pay out was often only two
or three years, unlike Alaska being 4 or 5 or more -
in terms of payout. We'd get our capital back and we'd
get a preferred return. Then the government would
increase the take to the 74 percent. I'll take that
deal any time.
11:08:55 AM
SENATOR WIELECHOWSKI asked what the general negotiated rate of
return was.
MR. THOMPSON replied that it would differ by whatever a company
could negotiate. A major corporation would calculate its cost of
capital based on how much the debt would cost and the cost of
issuing it and maintenance of equity. That might be an average
of 8 to 10 percent. Investors that hold stock want more return
than that from you because otherwise they could just invest in
the market. So often the rate of return might be 12 to 15
percent above the weighted average cost of capital. Some
companies, like exploration ventures with higher risks, often
were successful in negotiating a better preferred return and
sometimes for those kinds of interest that might be 15 to 20
percent after all taxes and burden. Once your capital is paid
back and you have your preferred return, then the high take of
74 percent was taken. He further stated:
I don't feel what ACES does to me is equitable and
fair because it's averaging in those types of regimes
that pay back the capital and get a return along with
the tax and royalty. And again, international
countries shown by the Department of Revenue on the
Governor's website for a tax royalty regime, the take
is 55 percent. And ACES says 68 for a similar type
system.
SENATOR WIELECHOWSKI said he was intrigued by the profit sharing
concept. He asked how investors would think if the state had
more of that type of system - it maximizes investments and the
take for the government, because it assesses each field. Both
sides negotiate so both sides know they are making money. He
asked, "Why don't more developed nations do that and would that
be something that would be acceptable to do in Alaska, do you
think?"
11:12:16 AM
MR. THOMPSON replied one of the things that makes it difficult
for Alaska to switch to purely that type of system is when
you're getting the capital paid back and the preferred return of
12 to 15 percent, the government take is very low - maybe only
10 or 15 percent (not the 68 percent). So if Alaska wanted to
immediately switch to that system, which he thought would
generate a lot more investment than either ACES or PPT, it would
take a few years for it to work out and they would have to fund
government from other sources like the Permanent Fund.
11:13:27 AM
SENATOR WAGONER said the state already has the ability to do a
reduction in royalties - like Alberta does with the oil sands -
until the companies recoup their capital investment, and asked
if that would be doing the same thing.
MR. THOMPSON replied that could be a compromise. He thought if
Alaska switched to the other system it would get more capital
projects going, but the problem is that the state would have
less revenues for a few years. For small fields like his it
would make an impact.
11:15:16 AM
SENATOR STEDMAN recalled the previous discussions on PPT that
covered the American tax and royalty regime and outside-America
profit sharing and rate of return scenarios. He urged them to
focus on the system at hand unless they wanted to spend a year
here in committee working on something else. He said they are
working on refining the PPT and he personally wasn't interested
in going back and starting over. They are talking about changing
the government take number.
CHAIR HUGGINS said he concurs and he asked Mr. Thompson to
proceed. He asked if Mr. Thompson does something in spruce bark
beetle work.
MR. THOMPSON replied he is a drummer in a band called the Spruce
Bark Beetles and quipped that he does it on the side pending
revenue from new discoveries. He went back to the subject at
hand and said it is hard for Alaska to change to a different
system. It should compare to other countries, not lumped into a
unique world of production sharing agreements with special
arrangements made for capital payback and return up front. He
stated:
Another distinction in regards to ACES is that most of
the individual people and company investors
specifically in AVCG do not consider international
regimes as areas to consider as competition for
investment dollars with Alaska. The main competition
for most AVCG Owners' cash is in other states in the
U.S. I found it astounding and concerning that the
average of 67 percent for all international regimes
did not consider weight-averaging in a little more
strongly the major American producing states. As
examples, the current government take in the Gulf of
Mexico offshore - one of the main competing areas for
Alaska investment dollars - averages 45 percent. This
is under consideration by the U.S. government for
increase, but it is highly doubtful with the boom
going on in deep water exploration and development
that the U.S. government would increase the government
take from 45 percent to ACES' 68 percent. Although I
think the government will increase the 45 percent.
11:18:57 AM
Now let me give you some astounding figures as of this
week. Yesterday we participated in the North Slope
area wide all acreage held by the state - on the North
Slope was up for bid - anything not yet taken. There
were a lot of bids and his company won six tracts. The
total of all bids is a little over $2 million. October
3, just a few days ago, at the Gulf of Mexico sale
205, and that was just one area of the Gulf of Mexico,
the bids were $2.9 billion - 45 percent tax burden.
The State of Alaska right now is going to 68 percent?
The bids were $2 million!
11:20:01 AM
SENATOR WAGONER asked what would be the government take if Shell
is allowed to proceed and strikes oil on their leases in federal
water on the North Slope.
MR. THOMPSON said those are federal leases and he didn't bid on
those. Most federal leases have a 12.5 or 16.7 percent royalty
and other federal taxation. It may trend slightly higher than 45
percent with the higher royalty.
11:21:07 AM
MR. THOMPSON continued:
In other producing states that compete for investment
by our AVCG investors, the state and federal combined
government takes in 2006 were as follows and averaged
45-57 percent:
U.S. Gulf of Mexico 45 percent
Colorado 51 percent
Wyoming 52 percent
Kansas 53 percent
Texas 53 percent
New Mexico 53 percent
Oklahoma 53 percent
California 53 percent
Louisiana 57 percent
To my knowledge, these states do not have the added
progressivity surcharge tax, which further separates
Alaska in government take from these competing states.
I would argue that Alaska should have a government
take of 55 percent to maintain long-term
competitiveness with these other states for investment
dollars. Having said that, some of these states are
examining their own tax structures and the Department
of Revenue was to have obtained current figures for
2007 for these states as some have changed their tax
rates. That would be good for the committee to look at
when that's available. But I don't think it'll be the
68 percent of ACES. In fact if we were to just step
back a bit and look at tax and royalty regimes
internationally, have a government take of 55 percent,
the Gulf of Mexico is 45 - headed upwards some and
then these other states average in the 50s, if Alaska
set a government take at 60 percent and 40 percent to
the investor, the ACES legislation should be amended
to allow for a base tax rate of 22.5 percent, not 25
percent, should be amended to allow for a trigger
price of $40 per barrel and not $30, and then the
incremental progressivity tax rate increase should be
0.2 percent per dollar. I calculated that by hand -
that the state yield would be 60 percent take and that
can be verified by having the DOR run some of their
models for those examples that I gave.
I think the 60 percent would be competitive with
states; it would increase above PPT slightly, but it
would also be something that doesn't stop investment
when people look at things like the Gulf of Mexico or
even federal waters offshore Alaska for investment
dollars.
11:23:33 AM
SENATOR WAGONER asked what if the tax rate went to 25 percent on
both sides - tax and credits.
MR. THOMPSON answered that wouldn't be as competitive as some of
these other total take tax burdens, but it could be looked at
with the new data DOR will collect.
11:24:26 AM
MR. THOMPSON said his final two points were on changing the
trigger price to $40 per barrel:
In particular there, if oil prices fall, many of the
small and medium size fields that our company is
looking at simply would not pass muster below $40 if
we did have the higher tax rate. And hopefully prices
do not fall that low, but it would make a big
difference if the trigger was $40 instead of $30.
There is a whole other wedge of smaller fields that
could be brought on stream, we think, if that trigger
price is left at the more reasonable $40 net.
Then my final point 4 on the last page of my comments
is it would be great if the state in my opinion could
consider some type of "Transitional Investment
Expenditure (TIE)" tax credit. This provision that was
in PPT was repealed in ACES. And this benefit or
provision does not greatly benefit our company, AVCG,
because we did not have large seismic or exploration
drilling costs between March 31, 2001, and April 1,
2006. In fact most of our drilling was this last
winter in 2007, but it is important to other major
investors in Alaska.
As an example, the largest explorer and developer in
Alaska, ConocoPhillips, now with the ARCO heritage
assets, was hardest hit in tax exposure with the
change from the old severance tax law to the PPT and
now once again to ACES. I think just allowing a good
steward who is the largest explorer in Alaska some
transition allowance to ease the pain of greatly
increased taxes is the right thing to do and can only
build better, more trusting relationships. Again, this
provision does not greatly benefit our company,
however.
This concludes my remarks. I tried to share the
perspective of an independent exploration company that
only invests in Alaska. My ultimate wish would be for
the state to leave PPT alone and re-review it under
the law as planned in 2011 or perhaps even in 2010.
But if the ACES train has left the station and cannot
be stopped, I urge you to at least consider the five
things our company would not change in this bill and
the four things we would change.
The above comments are offered with a hope that there
can be an eventual win-win solution to this complex
subject of the State realizing more revenues at higher
prices while attracting exploration and development
investors who can also realize upside at higher prices
for the substantial risk they have taken in the remote
and harsh environment of the North Slope. In the end,
I hope both sides get a fair and equitable share at
all price levels.
11:28:03 AM
SENATOR WAGONER asked the feasibility of a company his size or
bigger exploring and producing a field of 25 million or 50
million barrels when it's marginal. He asked:
What effect on a marginal field will the upcoming TAPS
settlement have in the tax tariff case that's before
FERC? Would that have a positive effect on your
ability to go out there and produce one of those
fields that are marginal right now?
MR. THOMPSON replied that the TAPS tariff increase that happened
last year was the largest increase of burden of any type that he
faces as a smaller explorer to ship oil down the line. He
declared:
We have no interest in that line. We have no interest
in the tankers or refining profits on the other end.
So we feel the full brunt in that that TAPS tariff
somehow could be reduced would be very significant in
developing marginal fields.
Having worked for years at ARCO, Mr. Thompson said he saw the
thing that most lowers the tax tariff per barrel is more
production in oil down the line. So, whatever ACES does to
encourage investment in exploration or allow fairness in
development projects increases the chances of more oil down the
line. And that's fewer tariffs per barrel on everybody. His
company is not involved heavily in the settlement, but the
increase last year was very discouraging.
11:30:10 AM
SENATOR WIELECHOWSKI asked what impact he saw on people coming
back to Alaska to look for gas if a gasline contract goes
forward.
MR. THOMPSON replied that they would most likely see more
activity in the foothills area of the North Slope. The largest
reserves would be the existing reserves at Prudhoe and Pt.
Thomson. Companies have been taking position over the last few
years hoping that the gasline deal moves ahead. ARCO felt there
was some significant gas potential in other interior basins in
Alaska - a couple hundred miles from Fairbanks, for example. He
hoped there would be more exploration in some interior basins as
well. He also pointed out that smaller fields can be more
economic when they have two revenue streams - gas as well as the
oil. He hopes a good contract is turned in and that the state
moves ahead with it.
SENATOR STEDMAN said they were talking about the Nenana basin.
SENATOR WIELECHOWSKI stated that they should consider that the
state is likely to see a significant amount more of investment
and exploration in Alaska with an impending gasline contract and
when they are thinking about loading up investment credit and
tax breaks, there's probably going to be a surge of investment
coming in anyway.
11:33:06 AM
MR. THOMPSON responded that he has worked big oil and natural
gas projects all over the world. At the time Arco merged with BP
in 2000, it was the third largest holder of natural gas reserves
in the Pacific Rim Basin. If Alaska does things right on the
investment tax credits on encouraging additional oil exploration
not only on state lands, but also offshore in federal waters and
the NPRA, there are still a lot of big oil fields and production
to come. He thought that would start up much sooner than a
gasline. "In my view, you need them both."
11:35:03 AM recess 11:42:27 AM
CRAIG HAYMES, Production Manager, ExxonMobil Alaska, Anchorage,
Alaska, read the following statement:
Good morning. For the record, my name is Craig Haymes.
I am the Production Manager for ExxonMobil in Alaska,
a position I have held since January 2007. I have the
pleasure of living in Anchorage with my family. Prior
to January this year I was involved with Arctic oil
and gas projects on the East coast of Canada for
almost five years. I want to thank the committee for
the opportunity to express ExxonMobil's views today
regarding the Administration's proposed tax increase.
Let me state upfront ExxonMobil believes the current
PPT tax rate and the increase proposed by the
Administration will have a negative impact on resource
investments in Alaska. ExxonMobil does not support the
proposed tax increase by the Administration.
We believe that Alaska needs to focus on a long-term
resource development policy. The policy should
encourage increasing investment that is needed to
maximize the development of Alaska's resources.
Alaska is rich in undiscovered resource potential, yet
oil production continues to decline from mature
basins. Oil production today is one third of the peak
of over 2 million barrels per day in 1988. Alaska
faces a significant challenge. We have a common goal
to maximize economic resource development and need to
work together; Government, industry, and the people of
Alaska, to enhance the development of Alaska's rich
resources and the future.
EXXONMOBIL IN ALASKA
ExxonMobil invests all over the world to meet the
growing need for energy. Over the last 20 years we
have invested close to $280 billion dollars to search
for new supplies of energy, build new production
facilities, expand refinery capacity and deploy new,
environmentally sound technologies.
ExxonMobil believes technology innovation is the key
to meeting the world and Alaska's energy challenges.
Technology is the lifeblood of our industry.
ExxonMobil currently spends close to $1 billion per
year on research and technology. We have consistently
applied our technology in Alaska to unlock and develop
resources. We have significant arctic experience
around the world.
Some examples of technology applications that we have
contributed to Alaska are:
· The installation of the ice resistant Granite Point
platform in Cook Inlet, which is still producing oil
· Significant research and engineering for the Prudhoe
Bay completion designs for permafrost
· The installation of the first Concrete Island Drilling
System (CIDS) to drill exploration wells in ice
covered waters in the Alaska Beaufort Sea
· The first full-field 3-D simulation model of Prudhoe
Bay, leading to many enhanced oil recovery and
development drilling programs that are still being
pursued today
The application of technology will continue to be a
key to the future of Alaska's resource developments.
ExxonMobil has had a presence in Alaska for over 50
years and has been a key player in Alaska's oil
industry development, spending and investing over $20
billion dollars. We hold the largest working interest
at Prudhoe Bay (36.4 percent) and our current working
interest share of oil production in the state is
approximately 150,000 barrels per day. We are also the
largest owner of discovered Alaska gas resource.
We are currently active with our co-owners at Prudhoe
Bay, Kuparuk, Duck Island, Granite Point and Point
Thomson. Over the last two years we have participated
in the drilling of over 70 percent of the wells on the
North Slope - over 130 wells were drilled at Prudhoe
Bay alone - this drilling will add 50,000 B/D of oil
production in 2007, an important contribution to help
mitigate production decline.
We are proud of the role that our company has played
in Alaska, which we believe has benefited both the
State and the industry, and we look forward to working
with Alaska for many years to come.
ALASKA RESOURCE POTENTIAL IS SIGNIFICANT
I would like to take a few moments to discuss Alaska's
resource opportunities. Alaska has significant oil and
gas resources. According to the US Geological Survey
and the US Minerals Management Service, Alaska's
undiscovered technically recoverable resources are 53
billion barrels of oil. This is in addition to the
Department of Natural Resources estimate for known
remaining oil resources of 6 billion barrels. To date
Alaska has produced close to 17 billion barrels of oil
- this is a world class result - but is less than one
fourth of the potential total of 76 billion barrels.
That is, Alaska still has the potential to produce
another 59 billion barrels of oil. The gas resource
potential almost doubles this undiscovered potential
on an oil equivalent basis.
Whilst Alaska's resource potential is high, the Oil
and Gas Journal and Energy Information Administration
report that its world ranking of proved reserves has
thth
declined from 14 in 1977 to a position closer to 30
today.
ALASKA's FUTURE OIL PRODUCTION
Today Alaska is producing approximately 750,000
barrels of oil per day from the North Slope, one third
of its peak production. The Department of Revenue's
production outlook, from their Spring Revenue Sources
Book, shows that they estimate a 9percent annual
decline in Alaska's current base production. As the
chart illustrates, at this decline rate, over the next
ten years Alaska's current base production, shown in
green, will drop to around 360,000 barrels per day.
That is a production level of less than half of
today's.
The Department of Revenue also forecasts that this
base production decline will be partially mitigated
with the development and production of oil in
categories called "Under Development and Under
Evaluation", shown in blue on the chart. These
categories include future investments, such as
development drilling, satellite developments, and
enhanced oil recovery from existing fields. Based on
this forecast, over 50percent of the projected oil
production in 10 years will come from new investments.
Let me say that again, 50percent of future oil
production in 10 years is not even developed or
producing today. Considering that most new projects
take at least 5-7 years to bring to production on the
North Slope, investment decisions for these
activities, particularly in the near term, will be
critical to underpin the future of Alaska's oil
production.
As I mentioned earlier, the Department of Revenue
forecast is based on a 9percent annual decline in
Alaska's current base production. However, this
decline assumes that production enhancement
investments at the core Prudhoe Bay, Kuparuk and
Alpine areas continue. The Department of Revenue
forecast, as shown, does not highlight that this
activity requires investment decisions that are no
different from the "Under Development and Under
Evaluation" categories. As such, a more accurate
representation of the future oil production and
investment levels required to achieve the Department
of Revenue forecast is illustrated in the following
chart.
As this chart shows, Alaska's oil production from the
North Slope could be as low as 150,000 barrels per day
within 10 years, (assuming 15percent decline, which is
typical for large oil fields such as Prudhoe Bay),
without ongoing and increasing investment. Based on
this forecast, within 10 years, 75 percent of
production will come from new investments.
Conservatively, we estimate that at least $30-40
billion of investment is required within the next 10
years to achieve the Department of Revenue forecast.
This does not include the billions of dollars of
additional operating expenditures that would be
required to support the developments once they are
producing. This is a significant level of future
investment and spending.
The high tax rate in PPT and the proposed tax increase
put this investment at significant risk. Alaska needs
to encourage the increasing investments required, not
only in exploration activities, but also in the
ongoing development of existing and new fields.
11:52:41 AM
SENATOR WIELECHOWSKI said ExxonMobil's annual report recognized
that the easy stuff has all been found and from now on huge
investments are required all over the world. He asked if that
was a fair statement.
MR. HAYMES replied that it is fair to say that the challenge of
finding new oil and gas resources is becoming more and more
technically challenged, but there probably is still some of the
easy oil out there. "We're all looking for it. There is no doubt
the level of capital investment that's required to explore and
develop the future resources for the generations to come is
going to be very, very high."
SENATOR WIELECHOWSKI asked if there are huge resource costs all
over the world. "It's not just isolated to Alaska is it?"
MR. HAYMES replied, "Alaska has some very unique aspects that
I'll talk about almost immediately in my testimony."
11:53:56 AM
SENATOR WIELECHOWSKI said regarding government take that a chart
by Chevron on the Alberta Royalty Review Panels shows that every
jurisdiction is raising oil taxes.
MR. HAYMES responded that it is useful to look at what others
are doing and learn from it, but they need to decide what the
right take for Alaska is to encourage more investment.
SENATOR WIELECHOWSKI said his point is if costs are going up in
every jurisdiction in the world, ExxonMobil is not going to
leave every jurisdiction in the world. The cost of getting oil
is going up for industry all over the world, not just in Alaska
and oil take by government is going up everywhere in the world
as well. "So, it's not just [in] Alaska that this is happening."
MR. HAYMES said there is no doubt that there is increased cost
in inflation and costs have doubled. Costs go up when oil price
goes up, so it is fair to say that all regions are seeing cost
increases. He said they have to look at what makes Alaska a
high-cost area.
11:56:23 AM
SENATOR WIELECHOWSKI said it is also an extremely profitable
region.
MR. HAYMES responded that production has declined to a third of
the peak. He said there gas potential doubles the remaining
production and these resources aren't being explored or
developed at a prudent pace. He said that government and
industry don't control all of the variables, but there are some
things that can be controlled, which he would talk about later.
SENATOR WIELECHOWSKI said ExxonMobil made $40 billion last year
and asked him how much of that was made in Alaska.
MR. HAYMES answered that ExxonMobil does not report its earning
on a state by state basis.
SENATOR WIELECHOWSKI said he knows that, but someone surely has
calculated that figure.
MR. HAYMES responded that ExxonMobil is a global company and
reports its earnings on quarterly summaries and in the annual
report.
SENATOR WIELECHOWSKI asked the question one more time and got
the same answer.
CHAIR HUGGINS said they would move on.
11:58:22 AM
SENATOR MCGUIRE digressed to say there is a question on where
Alaska sits on his company's investment timeline and ExxonMobil,
in particular, has been criticized for "warehousing" in Alaska.
She asked him to explain how Alaska fits into ExxonMobil
worldwide portfolio timeline. She invited him to mention
alternative energies it is looking into also.
11:59:35 AM
MR. HAYMES replied that ExxonMobil will always look at every
opportunity in the world to pursue energy. Its demand is
significantly increasing. It looks at many factors: the resource
potential, the technology required to develop that resource that
includes exploring appraising and developing, marketability, and
costs to develop the facilities.
They look at cost for an investment over the entire life of the
project - decades. The decisions are made. He said the most
important thing is the fiscal policy including predictability.
Because the investments are capital intensive and take quite
some time to generate a return they need to look at things over
decades. Alaska is an area ExxonMobil constantly looks at and
evaluates. The future of Alaska is not just gas, but oil and
gas. According to federal studies, half is oil and half is gas.
Currently they do not have a way to get the gas to market.
That's a challenge, but ExxonMobil continues to be active in
looking at ways to commercialize Alaska's gas.
12:02:53 PM
SENATOR MCGUIRE remembered a presentation she heard in House
Resources when she first started serving in the legislature in
2001 or 2002 that a representative from ExxonMobil said the
price of gas at the time didn't make development of Pt. Thomson
economic. Clearly today the price makes it economic. She asked
him to illustrate their decision making over that period of time
and explain why those leases aren't being developed.
12:03:57 PM
MR. HAYMES said he didn't mention price earlier in his
assessment and the reason is because ExxonMobil doesn't control
it. It is a commodity that goes up and down all the time. The
gas market is far more volatile than crude. Crude has gone up
recently and gas has gone down. When ExxonMobil looks at
economics for any project they look at sensitivities around
price, but focus on the aspects they can control like costs,
project execution, assessing the resource, the technology needed
to develop it and ongoing operations required. The government is
in control of the fiscal policy.
With respect to Pt. Thompson, he said, it is a gas field and it
needs a gas pipeline to commercialize it. He repeated that
ExxonMobil continues to evaluate ways to commercialize Pt.
Thomson and is currently working off-take studies with the other
owners and the AOGCC. They have continued their technical work
and have complied with all of the lease agreements, the statute,
regulations and the Pt. Thomson agreement. It is unfortunate
there is a dispute, but they will continue to do what is
necessary to move that along.
SENATOR MCGUIRE said that's the legal answer, but she wanted to
know why they don't want to get that gas in a line and get it
going.
MR. HAYMES replied:
We are absolutely keen to commercialize Pt. Thomson.
We have invested over $800 million and drilled 19
wells in the field. We are as keen as anybody to seek
a return on that investment. Pt. Thomson has a lot of
significant challenges - high pressure, reservoir
quality challenges; the technology required to develop
it is leading edge and of course it needs a gas
pipeline to produce the gas.
12:06:24 PM
SENATOR WAGONER said it is interesting that ExxonMobil won't
disclose profits they make in Alaska because BP and
ConocoPhillips did. He came down here with an open mind to come
up with a solution to the difference between PPT and ACES. The
fact that he is not disclosing their profits leads him to be
suspect when all oil companies come before the legislature and
say they are partners in producing and marketing Alaska's oil
and stated, "I don't think that's the way a partner acts."
12:07:40 PM
MR. HAYMES responded that Alaska is a high-cost region. Many
factors contribute to that including the severe climate,
sensitive environment, remote location and current restrictions
for future exploration opportunities. Alaska has two large oil
fields: Prudhoe Bay and Kuparuk. They have accounted for over 70
percent of the North Slope oil production. Assuming exploration
and investment activity continues in these fields, they could
remain at this level of production for the next decade. The
legacy fields require continuous investment to keep the oil
flowing. This is the same for any oil field in the world. During
the production phases there are many changes in operating
parameters such as reservoir pressure changes, oil, gas and
water production changes and changes in operating conditions and
on-going technical challenges. He said in order to keep the oil
flowing, these changes require additional investments, such as
the addition of water and gas injection and gas compression
facilities, which are historically significant investments at
Prudhoe Bay.
MR. HAYMES continued:
Currently, the owners spend over $2 billion dollars to
optimize and enhance production from Prudhoe Bay and
Kuparuk. These spending levels are in addition to the
capital investments pursuing new wells, projects, and
enhanced oil recovery opportunities. These operating
expenditures are essential to mitigate production
decline at these significant fields, which are
critical to the future of Alaska's North Slope oil
production.
Many of today's exploration and development activities
are occurring in and around Prudhoe Bay and Kuparuk.
As an example, since the year 2000 there have been
multiple Prudhoe Bay satellite fields developed -
Aurora, Borealis, Midnight Sun, Polaris, and Orion -
which are currently contributing over 40,000 B/D of
oil production. These developments would not have been
possible without the infrastructure and facility
sharing of Prudhoe Bay, which reduced the development
and operating costs of these satellites. As satellite
fields are developed it reduces exploration and
development costs for future new projects, as the
infrastructure on the North Slope expands. If the
major Prudhoe Bay and Kuparuk developments did not
exist, these satellite fields would not have been
economic to develop.
As another example, for the past seven years over 900
new wells have been drilled in Prudhoe Bay and
Kuparuk. The drilling of these new wells has slowed
the overall production decline from 12-15 percent to
an estimated 6-9 percent. Almost 40 percent of Prudhoe
Bay's production today is from these new wells.
12:11:56 PM
SENATOR STEVENS said he keeps hearing about reduction of oil
flow on the TAPS and that 300,000 barrels/day might not be
optimal to keep it going. He assumed that was an enormous part
of ExxonMobil's costs. He asked, "Can you just give me a little
insight as to how you decide what volumes you want to have
moving through that pipeline? And what would be optimal?"
MR. HAYMES replied that any oil field in the world similar to
Prudhoe Bay typically declines at 15 percent plus if you do
nothing. So they pursue as many opportunities as they can. He
said the decline rate is a challenge for everybody because as it
goes down, the unit operating costs go up. Typically a certain
amount of those costs are fixed and while technology can help
reduce those costs, "that decline is constantly against you." He
said the ExxonMobil looks at every investment on its own merits
and the full life cycle.
SENATOR STEVENS asked what factors ExxonMobil takes into account
in getting the volume up or allowing it to go down.
MR. HAYMES replied that the full life cycle of a field includes
different operating costs, capital investments, and different
sensitivities. It's a little like chasing your tail, when costs
go up they need to produce more oil. Each investment decision
rests on its own merits.
CHAIR HUGGINS recognized Senator Thomas in attendance.
12:16:26 PM
MR. HAYMES continued:
For the past two years, development drilling at
Prudhoe Bay has achieved the equivalent of the
important Oooguruk development. This example
highlights the importance of exploring for and
developing new oil in and around the Prudhoe Bay and
Kuparuk fields - all are important to the economic
benefit and future of Alaska.
Let me re-emphasize that Prudhoe Bay and Kuparuk have
the potential to continue to be critical contributors
to Alaska's oil production. They have the potential to
remain key hubs and enablers for exploration and
development of heavy or viscous oil, light oil and
gas. Encouraging increasing investment at these key
fields is as important as encouraging investment in
exploration and development of new fields. Without
these two hubs, Alaska will be severely challenged to
realize the full potential of its resources.
Progressing a tax policy that singles out and
penalizes these fields will discourage investment not
only at these fields but will also impact future
investment attractiveness to explore and develop other
Alaska oil and gas resources.
PROPOSED TAX INCREASE MORE COMPLICATED
In analyzing the Administration's tax proposal, we
found that virtually all of the provisions are simply
tax rate increases or further increases in complexity.
As an example, under the Administration's proposed tax
increase the two so-called legacy fields, Prudhoe Bay
and Kuparuk, would have a separate 10 percent gross
minimum tax and be segregated from each other and all
other North Slope fields. This gross tax would be in
addition to the base royalty payments. With this
minimum gross tax the state would be insulated from
price and cost risks, whilst retaining the upside
potential from the progressivity element. The
Administration is simply proposing to increase its
take while shifting the development risks to the
producers. Essentially, at low price, producers are
penalized.
Companies are willing to accept the risks of long-
term, capital intensive investments when there is a
corresponding opportunity for upside potential and a
sharing of risk should prices fall. Under the
Administration's proposed tax increase, investors will
need to assume a higher economic risk when making
funding decisions for future investments and spending.
The Administration has also proposed that all revenues
and expenses for the Legacy Fields will have to be
accounted for separately, with separate taxes paid for
each unit and their satellites. This would include
Alaska's heavy or viscous oil reserves produced from
those Legacy Fields - a resource that already has
significant economic and technical hurdles to
overcome. No other fields, units or regions within the
state would be subjected to these administrative
burdens.
The ring-fencing of the Prudhoe Bay and Kuparuk Units
makes the tax proposal more complex than the existing
PPT.
EXXONMOBIL POSITON ON THE ENACTED PPT
I believe it is important that I clarify ExxonMobil's
position on the current PPT. ExxonMobil did not
support the PPT that was enacted last year. As we
testified last year, we supported the concept of a net
based tax but stated that the proposed 20percent tax
rate, in the original PPT bill, would not encourage
the full development of Alaska's resources. We agreed
with the 20percent tax rate in order to support the
progression of a gas pipeline project.
The PPT that was ultimately enacted increased the
already high 20 percent base tax rate to 22.5 percent
with progressivity - more than doubling industry's
taxation. Alaska's current PPT tax rate is too high.
When combined with the gross royalties and the high
development and operating costs, it makes Alaska one
of the most expensive regions to invest.
There has been a lot of discussion recently on PPT
revenues and forecasts, which has been used in part to
support the Administration's proposal to increase
taxes. PPT has only been in existence for slightly
more than one year. The Department of Revenue has not
completed its PPT regulations or started any PPT
audit. ExxonMobil, like a number of the other
producers, met with the Department of Revenue several
months ago to discuss ways to help the State better
forecast its expected PPT revenues and we are willing
to continue those efforts. We are also willing to
work with DOR auditors to improve their understanding
of joint interest billings.
12:21:39 PM
FISCAL PREDICTABILITY IS IMPORTANT
I would now like to address another important element
of the business environment - fiscal predictability.
ExxonMobil and, I believe, the industry values a
predictable fiscal environment in which to make long
term investment decisions. Our investments are capital
intensive and are evaluated over timeframes of
decades. Any change in the fiscal regime has a direct
impact on how we view predictability of the Alaskan
fiscal environment, which in turn directly impacts how
we evaluate on a risk basis future investment
decisions. Let me reemphasize this point. Because of
the nature and magnitude of the risks associated with
any oil or gas investment, coupled with the amount of
time required to recoup that investment, fiscal terms
that are predictable are key to any investment
decision.
The Administration's proposed tax increase would
represent the third significant change to Alaska's
fiscal terms in the past three years. Changing the
fiscal environment for capital intensive projects,
that can take many years to generate a return, can
only reduce the attractiveness of future investments.
Each time taxes are raised, the attractiveness of any
prospective well or project diminishes and the
likelihood of it not being funded increases. For every
well or project not progressed, additional production
and State revenues are lost. As mentioned earlier, to
mitigate oil production decline Alaska needs to
increase investment. The Administration's proposed tax
increase will reduce investment.
ExxonMobil expects to be involved in Alaska for many
years to come. The policies established today and in
the future will impact the attractiveness of future
potential projects and the future of Alaska.
ALASKA NEEDS A LONG-TERM RESOURCE DEVELOPMENT POLICY
As I mentioned earlier, Alaska has significant
resource potential, but with many unique cost
challenges. It will take significant resources,
technology, investment and teamwork from everyone to
realize the full potential. Alaska and industry
collaboratively need to create a resource development
policy that encourages investment for long-term
production and growth. This is a complex issue and
needs significant time and effort from all parties.
It is beneficial to look at what others have done.
The Canadian province of Alberta has enormous
unconventional crude oil resources. Alberta's oil
sands represent the potential of over 170 billion
barrels of crude, and, like Alaska's resources, are
located in higher cost, remote arctic regions that
require significant investments to develop.
Alberta adopted a resource development policy
approach, designed to increase industry investment and
production. Their approach has proven successful due
to a number of key factors:
· Collaborative pursuit of resource development
objectives
· Development of technologies jointly with industry to
reduce costs, increase oil recovery, and upgrade
viscous oil to marketable products
· Creation of a level playing field for all projects
· Sharing risks with the investors by maintaining a
lower gross revenue based tax, that is, lowering
royalties significantly
· Providing long term fiscal predictability
Alberta's success suggests that Alaska should
seriously consider what other regions are doing to
encourage investment.
A long-term sustainable resource development policy is
required to enable Alaska to maximize its oil and gas
resource. There are many factors that need to be
considered. It is a complex issue. I hope that key
points addressed in my testimony are considered:
· Alaska has significant resource potential, but it is
in a high cost environment
· Oil production is already one third of its peak, yet
we have only produced one fourth of the oil resource
potential
· In 10 years, 75 percent of Alaska's future oil
production needs over $30-40 billion of new
investments - investments that are needed sooner than
10 years.
· Prudhoe Bay and Kuparuk are the 'hub' of the North
Slope, they represent 70 percent of North Slope oil
production for the next 10 plus years, can be the
backbone for future exploration and economic
developments, whether it is existing production,
future light oil, heavy oil, or gas. They need
increasing investments to achieve their potential.
· Development drilling at Prudhoe Bay and Kuparuk over
the last 2 years has added 50,000 B/D of new oil
production in 2007.
We propose a collaborative approach to develop a
sustainable long term resource policy that will
encourage the needed increasing investments and build
the future of Alaska for many generations to come.
ExxonMobil looks forward to working with the
Administration, the legislators, industry and the
people of Alaska in the future pursuit and development
of its oil and gas resources.
To encourage full development of Alaska's resources,
the PPT tax rate needs to be lowered, and should not
include a gross revenue based component. Increasing
investment fuels the economy.
Thank you again Mister Chairman for the opportunity to
testify today.
12:27:49 PM
CHAIR HUGGINS said ExxonMobil's image in Alaska has some
negatives, but it continues to be the state's business partner.
He heard on the radio that the number two investment return for
the Permanent Fund was from ExxonMobil. He didn't think it was
appropriate for everyone to ask how much ExxonMobil makes in
Alaska, which could be proprietary information; rather it is
important to figure out how to make ExxonMobil successful.
Sometimes people take exception to the way ExxonMobil does
business, but he hopes to continue doing business with them in
the future.
CHAIR HUGGINS recessed the committee to the call of the chair at
12:30:04 PM.
2:42:11 PM
CHAIR HUGGINS called the meeting back to order at 2:42:11 PM and
said they would have a roundtable discussion on issues in ACES.
Committee members present were Senators Huggins, Stevens,
McGuire, Wielechowski, and Stedman. In addition, he said LB&A
consultants, Dan Dickinson and Steve Porter; BP's Claire
Fitzpatrick; ConocoPhillips', Kevin Mitchell; ExxonMobil's Craig
Haymes; Alaska Venture Capital Group; Range Petroleum's, Ken
Thompson; Anadarko's Mark Hanley; from the Administration - DOR
Commissioner Patrick Galvin and Gaffney Cline & Associates' Rick
Ruggiero were in attendance.
^Roundtable
2:43:34 PM
CHAIR HUGGINS asked Mr. Ruggiero to comment on anything he
wanted to highlight about SB 2001.
RICK RUGGIERO, Gaffney Cline and Associates, said the issue he
wanted to make sure gets proper airing is that it is very
important to have the best possible information possible and
that it is very important to take care of the date of
disclosure. When he first met with Commissioner Galvin and his
team he was "aghast at the void of data that they had to do
their job."
He said there was a lot of press about a shortfall, but what he
saw as the companies came to the table is all of their data were
DOR figures. This was what they were using knowing that the
legislature would possibly be moving millions or billions of
dollars across the balance from them to you or the other way. He
was disappointed that they did not take the opportunity to come
forward with the best possible data.
2:47:20 PM
SENATOR WAGONER joined committee.
MR. RUGGIERO said new data is essential to making good models
and therefore good decisions. He was a bit taken aback by the
way the industry gave the DOR the right cost data the last time
around, although it was buried in footnote 8 of the AOGA
presentation, which says you should have gotten this and that
the DOR should have been able to figure out by doing the
mathematics that it does in the footnote, that the real cost
associated was in the $11 to $13 range instead of $7 to $8 range
- a major difference in trying to do predictions. These were
major differences that were known at the time that the
legislature should have had at its disposal to make a good
choice on how to set taxes going forward.
He said they need to have the right words in whatever they do
with the ACES bill to make sure the proper data does move with
violation of any SEC rules or anti trust rules. "There is
information that takes place that is transferred between oil
companies and governments around the world that you don't have
here and that you really need to have to manage your asset."
He repeated, "You deserve to have the best data known at the
time to move forward. You can't bet the bank on forecast data,
he advised the committee, but you manage your business as the
government the same way these companies manage their business
with their one, three, five and 10-year forecast. They deserve
to have the collective wisdom of the various companies in order
to do that business. The beauty of getting it from multiple
players is you kind of see how they do their estimation and get
an idea of what is robust and what's not.
2:53:21 PM
CHAIR HUGGINS said that's easier said than done. He is
flabbergasted with how little the state's knows - especially
after a special session has been called.
SENATOR WIELECHOWSKI said he is equally frustrated with the lack
of information the state has to administer the system it has now
- and also to decide whether the system is working and whether
it needs to be improved. He said:
We can't even get the profits from Exxon from last
year; it's something that I could probably figure out
with a calculator and about five minutes. And we're
sitting here and we have two senators asking that
question. We can't get that information and we wonder
why Alaskans - I mean I get emails every day, phone
calls every from constituents. Go to the gross, go to
the gross. You can't trust the oil industry. And when
I see behavior like where I can't get simple
information. That's why Alaskans are saying that.
That's why Alaskans are hesitant and they are
distrustful and think we should go to the gross -
because they think we're getting gamed. If we can get
the information, maybe there is a better way to do it,
but if this is the way the relationship, the
partnership, is going to be, then it's no wonder why
most Alaskans want to go to the gross.
CHAIR HUGGINS asked if the DOR has the answers to what the
different organizations' bottom line within the state is, but at
any rate the department could come up with the figures on its
own "with 15 minutes of homework."
COMMISSIONER GALVIN responded that he revealed profits for
ConocoPhillips and BP as far as Alaska operations go. Most of
those operations take place in partnership with Exxon and the
math could be done based on ownership percentages, but he hasn't
done that because the number isn't relevant to his position on
this issue and nobody has asked them for it.
CHAIR HUGGINS asked if his was the appropriate agency to deduce
those numbers.
COMMISSIONER GALVIN replied that probably the DNR would be the
department to do that calculation because it knows the
percentages of ownership.
2:57:16 PM
MR. DICKINSON said three specific questions were addressed. The
first question dealt with the notion of penalties, interest and
what happens when companies under declare. He clarified that the
current law has two interest regimes - one deals with estimates
and interest on overpayment or underpayment through March 31.
The interest rates there are IRS interest rates, which means
there are four. One rate is for a "large overpayment" - if the
amount of tax that was underpaid is over $100,000, it's the
highest of the four rates. If the amount that is due that month
is under $100,000, then it's a slightly lower rate. If the state
owes money (an overestimation in a month) there's another rate.
The fourth rate is for under $10,000 or $15,000. There are four
rates in all; all of those rates are lower than the state's
rate. And on March 31 you take everything that has happened so
far and that becomes a single amount of tax due - or underpaid
or overpaid - typically if history is any indication - the
amount underpaid. That then bears the rate found in the general
tax statute. That rate is San Francisco discount rate federal
funds rate plus five points or 11 percent. Typically for most of
the year since that went into effect it has been at the 11
percent compounded quarterly. He said that back in the early
80's the state's rate was 8 percent simple and there was a sense
that the state could be essentially used as a bank. It made
sense to under declare because you could earn a lot more than 8
percent simple elsewhere.
3:00:17 PM
MR. DICKINSON said the point he wanted to make is after March
31, those rates apply to all other tax types save one. He said
the same rate is applied to all taxpayers.
He said that people get confused because of the IRS that has
separate and distinct civil penalties that can be levied if you
purposely ignore the law or if there is misconduct and things
like that. And then finally there are actually very severe
penalties for fraud. Where there is an honest dispute between
the taxpayer and the government as to whether a deduction was
appropriate or how much tax is owed, that is the 11 percent
compounded quarterly and that can go higher if market rates go
above 6 percent.
He said that same question here was how that compares with other
states - and it is higher than what other states have; but he
didn't get a chance to compare it to other peer nations like the
UK or Norway.
CHAIR HUGGINS asked if the state is using the IRS practices in
its penalties.
MR. DICKINSON replied only in a year for underestimations or
overestimations of the amount.
CHAIR HUGGINS asked if there are distinct statutes or provisions
for people that by design or omission did something.
MR. DICKINSON replied yes and that could be up to a 25 percent
penalty. He said if there's any messing around or proof of bad
faith on an item, that penalty can apply to the total amount
underpaid, not just that item.
CHAIR HUGGINS said it appears that it's a more wholesome task
than one would want to bite into in 30 days to rejuvenate the
penalty factors, because there are a lot of moving parts and the
synchronization of that is such that you need time and it's best
measured in months, not days, to pull that off.
COMMISSIONER GALVIN answered it depends on what their objective
is. If it's to have a fairly straightforward penalty apply in a
particular situation, it's simple, but if it's going to be more
integrated into the entire system that would apply across other
tax types, it would take more time.
CHAIR HUGGINS said the provision this bill contemplates takes
the $100 per day to $1000, which is a tangential piece.
MR. DICKINSON replied that really applies to information so you
can't take a percentage. With a six-year expanded statute of
limitations that basically says monthly reporting is required,
that starting six years from now in its most extreme case the
state could level a new penalty of $2 million every month
($1000/day X 365/days/yr X 6/yrs = $2,000,000). This is a very
heavy penalty for underreporting especially if you don't notify
the company until six years later.
SENATOR WIELECHOWSKI said if they're paying only interest, they
have that money, say $1 million. They can take that $1 million
and invest it somewhere else and with a discount rate of 10
percent, it's basically a break even proposition. It's not
costing them anything else.
MR. DICKINSON said if their discount rate is 10 percent, they
are losing money.
SENATOR WIELECHOWSKI said 1 percent and they have heard profit
ratios of 35 - 45 percent from all the companies.
CHAIR HUGGINS commented that didn't sound like a very good
investment strategy.
3:05:37 PM
KEVIN MITCHELL, ConocoPhillips, commented that 11 percent
interest is a significant rate. He would view that as "quite the
penalty." So from his perspective, there is no incentive to
overclaim expenditures and be subject 11 percent interest
compounded.
3:06:39 PM
MS. FITZPATRICK added that with the proposal to move the statute
of limitations to six years, an audit could take them out to 8
or 9 years. To be told after 8 or 9 years what you had done in
good faith at the time is now wrong, then they stand the best
chance of not over or under claiming, but actually doing it
properly.
CHAIR HUGGINS asked if she said that BP needs regulations to
comply.
MS. FITZPATRICK clarified, "I said if we're actually when we're
doing our filings, knowing what the regulations are, that means
we stand the best chance of knowing whether or not we are making
a compliant filing or not."
SENATOR GREEN arrived - all present
3:09:40 PM
MR. DICKINSON said the request was to model a 22.5 percent
versus 25 percent without a floor, but with an aggressive
progressivity. On that issue, he observed that the amount of
revenue available for division among the parties (whatever the
rules are) when they are down in the range of $9/barrel and the
state is taking 62 percent of some profit piece from that is
literally a question of cents or a dollar. When you are up at
the current range of ten times that (way above the lifting cost)
at that point if the state has a more assertive progressivity,
the amount that will be picked up may equal what it will give up
(if you view those as a trade off) over five or six years as at
low prices. It's not symmetrical to move something at low and
pick it up.
And I believe that the state essential if they pick up
the windfall profits or the spikes, you can do a small
number of profits. Spikes will make up for many years
in which you have a policy where if investments are
being - the combination of investment, cost and low
price leads the state to have a very very low take.
So, it's my observation that the floor may have a very
chilling effect when prices are low and if it's a
revenue issue, that you may pick it up at the other
end. If it's a sufficiency of revenue issue, the only
other observation I would make and I think I made this
for your committee before, and I hesitate to make it
again, because it's stepping a little outside of my
area of expertise, but when the state was young it
maybe made sense to have a regressive fiscal system
when the oil was sort of first flowing in because that
really was the state's only source. As you know, three
years after Prudhoe Bay started producing there was
the first price spike and at that time the state
repealed its person income tax and repealed its gross
receipts tax on business and decided this was the new
frame of reference. And I don't know that we need that
any more. The state has put a significant, a quarter
of all the royalties, have been put aside. You as the
legislature have added certain increments to that so
there's a lot of money sitting there over and above
the protected corpus. There's dollars that are sitting
there that could be drawn on, the CBRF is sitting
there. So it may be that if I can put this in sort of
betting terms, the state's risk tolerance may be such
that you're willing to accept some of that high side
and when prices are low and everyone is challenged we
don't need to say well - as I believe you can show in
1999 for a couple of months, we were taking 110
percent of the economic rent. That's just an
observation on those two and I know you want some more
quantitative and if I have the chance I will certainly
do that and present that to you.
3:12:00 PM
CHAIR HUGGINS said there's not a lot of affection amongst some
on the floor because of what he just described. Somebody said it
would be like upping property taxes in the late 80s. Nobody
would like that very much; nobody had much money to pay it and a
lot of people were out of jobs.
3:12:42 PM
CRAIG HAYMES, ExxonMobil, said the challenge of the 10 percent
gross floor is when you look at your forward investments, as
investors they would need to assume that kicks in and be able to
use that as a basis for economics.
And that's a significant deterrent when you look at a
return on a significant capital investment that takes
decades to get a return. So the problem is whilst we
may not be at the floor today, because the crude price
is at ridiculous levels, the dynamics of the oil
fields and the costs and commodity price will change.
We never know where it's going to go, but for
investment decision purposes, we would need to assume
that floor kicks in - given unit costs on mature
fields will continue to increase - given the commodity
prices. If you look at history it shouldn't be above
$40 or $50/barrel and given currently the production
is declining. So, for us it would be if it was in
there, even though it may not be happening today, we
would be assuming it is going to happen. So, it would
reduce the attractiveness of future investment
opportunities.
3:14:14 PM
KEVIN MITCHELL, ConocoPhillips, echoed those sentiments about
the floor. He is concerned that the floor would be triggered in
a low-price environment which makes a very regressive tax. So,
they would be getting effective tax increases at the time when
the industry can least afford it. The second is that the
potential investment opportunities could be impacted by that
floor and in testimony yesterday he outlined how they could be
at the floor simply because of trying to pursue investments that
will drive some growth. This is a significant area of concern.
CHAIR HUGGINS inserted that tomorrow they would get together
with the administration to discuss what scenarios would activate
the floor.
MS. FITZPATRICK said BP, to err on the side of caution, would be
making its decisions assuming the floor kicks in. If they pursue
investment to get more barrels, that might in fact trigger the
floor, which means she would question the value of making the
investment in the first place - making it a viscous cycle at
that point.
3:16:15 PM
COMMISSIONER GALVIN commented that their level of investment in
order to kick in the floor would exceed what the state has seen
in the past. He said the administration has acknowledged from
the get-go is that there is a trade off.
You can take the side of wanting to protect the
state's interest when prices are low and minimize the
risk of having the significantly low revenues in times
of low prices and we recognize the opportunity to take
a greater take on the upside when prices are high. And
what influenced our decision was more of a
conservative view that we would rather protect the
state when there are low prices. But again we said
from the get-go that this is a policy call in terms of
that risk/reward trade off that is up to the
legislature to respond to. I think I hear the same
hallway chatter with regard to the floor and we're
open to discussion about the validity of that in
replacement for higher on the upside, but in the end,
I think it's a responsible thing for us to consider in
terms of a trade off there - and make a reasoned
decision that we're going to do something else.
SENATOR WAGONER said he has heard a lot of good debate on both
sides. He thinks it's only fair if the state shares in the
upside it should share in the downside.
3:18:57 PM
CHAIR HUGGINS said his perspective is that some parts of the
bill need more airing and there are two other committees for it
to go through. Its merits will continue to be reviewed.
3:19:24 PM
MR. DICKINSON said Mr. Mitchell made an interesting observation
in a similar roundtable and one idea people like is the hybrid
of a gross and a net and if there's some way of combining them
that makes sense. Mr. Mitchell said that progressivity
essentially acts like a gross, but maybe it could be redesigned
to have the elements of a gross at the very high end because at
that point it becomes very close.
3:20:24 PM
MR. MITCHELL elaborated he believes that the marginal basis the
net structure with progressivity behaves very like a high gross
rate. If you look at today's $80-plus barrel price, costs
haven't jumped by $20/barrel over the last three months as
prices have moved from $60. So there is a bigger margin, but
that entire margin is being taxed from a production tax at 27 -
28 percent rate plus the progressivity. That's in addition to
the royalty and the other taxes of corporate taxes and property
taxes. He said the state gets the best of both worlds by sharing
on the high side and getting the investments through the tax
credits.
3:21:48 PM
MR. DICKINSON said the third topic was a request to provide to
the Senate Resources Committee an explanation or illustration
regarding the $800 million shortfall - what it's based on and
how the DOR arrived that number. While he said the commissioner
of the DOR could better explain that number, he wanted to
summarize several ways of looking at the gap. He referenced a
handout labeled "Summer '06 versus the Spring '07 Forecast for
Fiscal Year 2008."
The fiscal note indicated for two different prices: one said at
a price of $46.90 that the state would bring in $1.5 billion and
it gave a high side estimate of $60 and said they could expect
to bring in $2.4 billion. Eight months later in 2007 the spring
forecasts came out and a number of adjustments had been made -
and it said they could expect to raise roughly $1.billion. His
point is the difference between the revenue forecast at $1
billion and the fiscal note from eight months earlier at $1.5
billion is roughly $500 million.
Another way of looking at it is clearly recognizing the effect
that prices have. And what would the fiscal note have been if
the price forecast used had been $54.72? That suggests it would
have been roughly $2 billion in revenue instead of the $1
billion forecast by the DOR. So there is a $1 billion gap on
this very simplistic basis. He had not doubt there are a lot of
other tweaks that can account for the smaller differences
between those.
MR. DICKINSON asked if the major issue that everyone is focusing
on is cost, what difference would a doubling of costs from $2
billion to $4 billion produce. He answered:
So, we start with an incremental $2 billion. What's
the tax effect going to be? Let's further assume
really simply that $1 billion of that was higher Opex
and $1 billion of that is higher Capex. Okay, what's
going to happen? The Opex, if there's $1 billion extra
dollars, that's going to make taxes go down by $225
million. It's that simple. If your tax rate is 22.5
percent and there's $1 billion more in deductions,
it's $225 [million]. So you can think about your own
income tax when I have $100 deduction, I save $22.50
in tax. You know, it's the same idea.
Capital investments, though, capital spending, starts
out with the same thing because that's also
deductible. Then you have the ability to take a 20
percent credit - so that gets added on - and then
finally another very simplifying assumption I've made
here is that in this the second year of the PPT, that
there's enough TIE investment available so that the
two for one match is fully utilized. So whatever
credit there was essentially, TIE, to match it comes
in and the net effect is you add additional 10
percent. So I added 22.5 and 20 percent and 10
percent. So the effect of an additional capital dollar
is the state basically gets $.52.5 less in tax or to
go back to my analogy if there's $1 billion in extra
capital spend, that should knock $525 million out of
the tax receipts.... So, you take the 22. 5 and the
52.5 and you combine them and it's an average of 37.5
and you multiply that times $2 billion and you get
$750 million.
All I'm trying to do with this simplistic thing is say
sitting back, the Department of Revenue has seen this
$2 billion increase and yes you'd expect everything
else being equal for that to be about $800 million. I
think it's very important to distinguish that kind of
analysis from the revenue's efficiency analysis - the
numbers that you looked at then you pass budgets and
items like that.
3:28:45 PM
COMMISSIONER GALVIN said the gap exists and Mr. Dickinson just
showed them two ways that validate those numbers. The question
is moving forward that acknowledging that the folks from BP and
ConocoPhillips said their numbers match up with the state's.
MS. FITZPATRICK agreed and added when BP looks at current costs
as an individual company, it has only part of what the state is
looking at. But she felt comfortable with the 2007 numbers.
MR. MITCHELL pledged to work with the administration in sharing
data.
MR. HAYMES pledged to not be so ambiguous.
MARK HANLEY, Anadarko, echoed previous comments on adequate and
correct information.
3:34:53 PM
COMMISSIONER GALVIN said the nature of actually getting to that
desire of sharing of information comes down to the state saying
it wants this information and then it gets a reaction from the
companies asking if the information is really critical and
necessary. There is a different perception between the state and
companies when it comes to how valuable it is. There needs to be
statutory authority that information needs to be provided.
That's why it's in the bill. There needs to be very
clear statutory authority that says the taxpayer shall
provide this information in a way that avoids having
individual conflicts over whether or not certain
aspects of certain types of information are really
meant to be provided in a very general statement about
how they shall provide whatever information is
necessary for the state and you end up with conflicts
on a daily basis over whether that's really necessary
or not. That's why we're trying to provide in the
statutory language some clear definitions of what
needs to be provided.
SENATOR WIELECHOWSKI said one of the things he's confused about
in the overall argument is PPT was supposed to raise $2.2
billion and it actually raised $1.4 billion. But last year the
industry expected to pay $2.2 billion in taxes and it ended up
paying $1.4 billion.
COMMISSIONER GALVIN corrected that last year in FY'07 it was
supposed to bring in $2.2 billion if all the numbers were lined
up; but it brought in $2.0 billion; when you look at FY'08 with
the current costs they are looking at a $800 million shortfall.
SENATOR WIELECHOWSKI said that ACES would have them pay less
than they expected to pay under PPT.
MR. HANLEY said he raised this issue upstairs as well and a lot
of what was debated during PPT was how much is the right
government take and for the companies to have. One thing seems
to be forgotten and it's the fact that if companies paid less
than they expected to pay, it was because their costs were
higher and it cost them more. When everyone figured out the 22.5
percent tax rate, that was based on having a lower cost as well.
Results show they had a lower return than was expected, too. "It
is important to remember that while the state lost money, so did
the companies - if that's the case." There is also the
difference between a cost and investment and part of the reason
there's $200 million less is that people went out and spent $500
million more in drilling new wells, not just new cost increases.
3:39:52 PM
COMMISSIONER GALVIN responded that it's important to reflect on
who knew what when. The companies clearly paid less than the
state expected and it's true that a company's margins are going
shrink with increased costs. From a year ago, they may have paid
exactly what they thought they were going to pay, it just
wasn't' necessarily what the state thought they would pay. It's
an important distinction.
SENATOR WIELECHOWSKI asked how much of the state's information
he was relying on when the state's estimates were made and if
this is one of the things ACES is going to fix.
COMMISSIONER GALVIN replied in a way. A year ago the state came
up with estimates and provided them to the companies that kind
of said well maybe you're a little low here or over there, but
the information didn't come from the companies per se. They
didn't actually report anything; they didn't sign any
certificates; it's not like this year when they had actually
filed returns where they certify these are their costs and
provided them to the state and that's what it is basing its
information on now.
SENATOR WIELECHOWSKI asked if it's fair to say the state
suffered a shortfall because the department underestimated how
much their expenses would be.
COMMISSIONER GALVIN replied the department underestimated what
their costs actually were.
SENATOR WIELECHOWSKI said the department got its information
from them.
COMMISSIONER GALVIN replied that the got its information based
on a variety of sources; he then had conversations with the
companies; and that they didn't correct it is probably the more
accurate was of putting it - as opposed to that they didn't give
it to him.
CHAIR HUGGINS said when he listened to Dan describe his old job
with the Division of Tax, that the projections were surprisingly
accurate.
MR. DICKINSON added that on one level it was a classic case of
the division overestimating volume, which it had done 18 out of
19 of the past times, and underestimating expenses and
underestimating price. The net effect of those was the number
that came within 8 percent of the projected number. He added
that Commissioner Galvin described the process exactly, but one
step further - the information he had from companies was blended
from a lot sources including partnership returns for unit
investments on the North Slope. That's really the only
information the companies provided. Other estimates were put
together from Wood MacKenzie, for instance. Among the people who
reviewed it were the companies, but also the legislators'
consultants - looking at ballparks and sensitivities. "I guess I
would just characterize it there was a lot of discussion about
them, but no flags about whether they were way off, but you're
right. Nobody put someone under oath and said do these numbers
represent X, Y and Z."
SENATOR MCGUIRE remembered that there was a clear policy
decision to incentivize their industry.
But the spirit I would like to convey when you think
about legislative intent and the debates that went on
for eight months of last year is that there was a very
clear policy decision to incentivize your industry and
I think you should really walk away feeling good about
that. The legislature has debated taxes in my tenure
on alcohol and tobacco and car dealerships and all
kinds of things. And in no case have I ever heard a
desire on the part of lawmakers across the state to
say let's incentivize this industry. I mean we are not
saying to liquor stores we're going to go ahead and
give you some credits, because we would like to see
more people drink. And so - but I think it's an
important thing to point out that with that benefit
comes tremendous responsibility. And that what we're
expecting is not - and I'm not implying it's occurring
- but not a game of cat and mouse or battleship, but
rather that focus on the partnership part and that we
are wanting to help you incentivize your industry. And
so when you're thinking about what kind of costs or
investments go in, then it's really a matter of are
you investing in the state? Is it something that's
going to grow your industry, create more jobs, bring
more profits for you, but also for the State of
Alaska. And so I look forward to a better sharing of
data, but if it gives you the spirit of what we're
thinking about, we may not get it right every time, we
may not get every word in the right spot of what we're
trying to define. I think that's the difficulty of a
citizen legislature; we're not economists; we're not
petroleum engineers; we can't identify everything;
neither can the department frankly. But the spirit is
please work with us; we're trying to grow your
industry for the benefit of all of us.
3:47:07 PM
MS. FITZPATRICK said everyone was collectively in agreement with
each other on the principle of getting something workable.
COMMISSIONER GALVIN said that the state needs to make it clear
exactly what is required.
3:50:27 PM
SENATOR WAGONER commented that ConocoPhillips' chief economist,
Marianne Kah, last year sat in this same committee room and said
something that was probably very important and that they didn't
pursue very much - that costs were on the increase and could
double. He asked her if labor was included in that and she
replied probably not. He thought they needed to be more thorough
on both sides when the forecasts are being made - and be a
little more honest with each other because she had it pegged
pretty well.
MR. MITCHELL agreed that Ms. Kah is sharp and very accurate.
3:51:55 PM
MR. HANLEY recalled that a little bit of the pressure last year
is that the companies were padding their costs to make their
returns look lower. So, this year, they are sitting here
listening to the legislature is telling them they didn't tell
them the costs were high enough.
3:53:48 PM
CHAIR HUGGINS said as he understands it there is a little bit of
change in how they are going to state deductions. Instead of
exclusions, the law will say what you can deduct.
COMMISSIONER GALVIN agreed and explained that the state through
regulations will identify what can be deducted.
SENATOR GREEN asked if they will still have exclusions.
3:54:36 PM
MR. DICKINSON replied that the structure still starts with a
high level statement (in section 165); it says it has to be a
direct cost of producing, exploring for or developing oil or gas
in the state and all the other qualifiers. Then section (e) sets
out the current 17 (and this bill would add two more) specific
exclusions - so that no matter what, those are no longer
deductible. The change, as the commissioner said, is there's not
going to be an intermediate step which says the department has
to write regulations and unless the department's regulations
allow for it, it is prohibited as a deduction. So the department
is taking the general notion of a direct cost of exploring for
developing or producing oil or gas in the state (with four other
qualifications) and turning those into regulations.
3:56:29 PM
SENATOR GREEN recalled from the previous years that they were
sort of the warned not to list too many things one way or the
other for fear that something would inadvertently be omitted and
therefore become litigious. She asked if the goal he was
shooting for was to avoid listing too many items.
COMMISSIONER GALVIN replied that it really depends on the nature
of the definitions. As Mr. Dickinson said, you can define things
in the broad category and leave a lot of open room for
interpretation within them. The limitation is if you try to
identify all of the nits and you miss something, then there's an
inverse interpretation that you intended to exclude that nit.
The balance is to find things in such a way that you insure that
you have maximum inclusion of what you are trying to include and
minimize things that you clearly don't want to have in there. He
said his regulations would be two or three steps down in that
fine tuning.
SENATOR GREEN asked if that could be done with maximum accuracy
and fairness or does it advantage the department to be able to
define passed legislation in regulation.
COMMISSIONER GALVIN replied that the regulatory process allows
more interaction with the taxpayers being able to have a
discussion of the technical details in a context that allows for
them to be fleshed out a bit more. It adds a level of avoiding
unexpected exclusions and flexibility to have the conversations
with industry before going through litigation.
3:59:11 PM
CHAIR HUGGINS followed up saying his concern was more elementary
and if the department hadn't been able to do audits, how well
could it do definitions.
COMMISSIONER GALVIN replied that the language of the statue and
the intention of the effort is going to be based upon industry
standards, not upon going into the audits and deciding
retroactively what should or shouldn't be included.
4:00:10 PM
MR. HAYMES said he was concerned that the draft bill was
ambiguous. He said the 30-cent allowance was objective, but any
time you get into prescription it's going to be very subjective.
It will create a lot of confusion and ambiguity and auditing of
auditors. He was very concerned that regulations could be easily
modified. "And again it kind of gets back to if there's a lot of
ambiguity; then we need to assume a worse-case scenario in
future investments - not knowing how it will be treated until
you're way down the pipeline so to speak." He implored them to
make the definitions as objective and transparent as they can.
4:01:41 PM
SENATOR WIELECHOWSKI asked Commissioner Galvin if his position
has evolved in any way after hearing the testimony about credits
over one year versus two years. It seems it benefits the smaller
independents to go one year and the larger companies say it
doesn't have that big of an impact.
COMMISSIONER GALVIN replied that his position never really
evolved. He recognized that it was basically a trade off issue
and the difference going from one year to two years is simply a
matter of taking 50 percent and discounting it by time value of
money in one year. Clearly a project would have to be fairly
marginal for that to make a difference between whether you're
making money or not. But it's just whether the value to the
state is really offset by that. He saw value in the smoothing
aspect of it in terms of blending variable costs from one year
to the next for simple forecasting.
MR. DICKINSON emphasized that the value to the state is really
small for a technical reason. He explained that the projections
the state has to deal with are based on a fiscal year. So, as
you make an investment in the later part of a calendar year and
then are forced to move half of it into the next calendar year,
it's still going to be on the same fiscal year plate. So,
instead of half being moved forward, it's more that quarter gets
moved out to that next fiscal year and three quarters of the
effect of it could be in that first fiscal year.
4:05:28 PM
SENATOR WAGONER said it's the same dollars in the end to the
state no matter how the pie is cut. He wanted to simplify
anywhere they could.
SENATOR WAGONER said this provision only affects the explorers.
The producers take those credits against their production tax.
COMMISSIONER GALVIN said they only get half.
4:06:07 PM
MR. MITCHELL said it's not a huge financial impact, but it's
still a form of tax increase and an erosion in value if you look
at project economics. However, the allowing credits to be
deducted over two versus over one year is not a huge factor in
considering whether a project gets done or not.
MR. HAYMES said the key for Exxon is that it adds a lot more
administrative burden to both the investors and the DOR. If the
intent is to incent more investments, this doesn't do it.
SENATOR STEDMAN said he would be considering this along with
forecasting and planning the state's budget cycle in the Finance
Committee. He wanted to get as much predictability into the
process as possible.
CHAIR HUGGINS announced that Senators Thomas, French, Hoffman
were in attendance.
4:08:44 PM
CHAIR HUGGINS went to the issue of changing from monthly to
annual reporting and asked the commissioner to explain the
rationale behind that.
COMMISSIONER GALVIN explained that in calculating the
progressivity he realized that they are asking the companies to
do a little bit of an artificiality where they would take their
anticipated annual costs and have to divide that by 12 months
and calculate their income for a particular month. That would
establish their net value, which would then kick in the
progressivity. Thinking through the basic fairness of it with
constantly changing prices and price spikes that may last a week
or two, the inherent randomness of having a spike that takes
thth
place between the 10 and the 30 of the month may create a
tremendous progressivity payment whereas if it took place
thth
between the 20 of one month and the 10 of the following month,
it may have no impact at all. And he thought there was just a
basic fairness aspect to having progressivity calculated over
the entire year - have it be the annual price and have it apply
basically to one chunk on an average basis.
He said when he ran the models for last few years, prices were
pretty volatile and he figured the state would be out $10
million to $20 million per year from doing it on annual basis.
Basically given that we are increasing the
progressivity across the board, it was sort of one of
those trade off things that was well okay, it will
make it a little bit easier to calculate and a bit
more fair in its application and although it does cost
the state in the end, it was from my perspective an
appropriate tradeoff.
4:11:35 PM
MR. HANLEY said annualizing it generally saves the companies
money, which means it would cost the state some money. And that
in itself wasn't hugely significant, but it's important to point
out that in his view the changes that were made to the starting
point and the escalator were actually a significant tax increase
at a $60 price.
4:13:28 PM
COMMISSIONER GALVIN said it was not the intent to make these
equivalent tradeoffs and he recognized the change in
progressivity that would bring the state significantly more
money. Going to the annual was a nod to fairness and a little
bit easier calculation.
CHAIR HUGGINS asked if they agree that annualization is simpler.
MR. HANLEY replied yes.
MR. DICKINSON added in that the creation of the monthly
progressivity was one of the uglier things in PPT, but having
said that, one of the reasons it was done was because there was
a definite focus on capturing spikes. "If that's not a concern,
then clearly an annual return is much simpler than 12 monthly
returns."
CHAIR HUGGINS thanked everyone for their comments and adjourned
the meeting at 4:15:43 PM.
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