Legislature(2015 - 2016)BUTROVICH 205
04/09/2016 09:00 AM Senate RESOURCES
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| Audio | Topic |
|---|---|
| Start | |
| SB130 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | HB 247 | TELECONFERENCED | |
| += | SB 130 | TELECONFERENCED | |
| + | TELECONFERENCED | ||
| + | TELECONFERENCED |
SB 130-TAX;CREDITS;INTEREST;REFUNDS;O & G
[Contains discussion of companion bill HB 247.]
9:00:49 AM
CHAIR GIESSEL announced consideration of SB 130.
PATRICK FOLEY, Sr. Vice President, Alaska Operations, Caelus
Energy Alaska, Dallas, Texas, said he is responsible for all of
Caelus' Alaska operations. He was sorry to not be present
physically this morning. He was at their world-wide headquarters
in Dallas resolving some "very significant employment issues" in
planning for their 2016 operations. He would be back in the
Anchorage office on Monday to deliver a very unpleasant message
to about 25 percent of his workforce.
He said the slide presentation is the same series of slides that
he previously presented and testified to in other committees on
this same bill. He would not go through that pack page by page,
but he would focus on key issues. He would also emphasize some
of the points raised in President and CEO of Caelus Energy, Jim
Musselman's, letter to the Governor on Friday.
CHAIR GIESSEL noted that members had received that letter.
9:03:15 AM
MR. FOLEY said Caelus, combined with their Pioneer heritage, had
spent an aggregate of $2 billion in the State of Alaska,
produced 23 million barrels of oil, and last year had a drilling
capital budget of roughly $300 million. That work activity has
earned them about $100 million in transferable tax credits.
Over the last several years, Caelus had employed about 300 hard-
working Alaskans focused on four projects: Oooguruk (offshore
the Colville Delta), a companion onshore project called Nuna, a
400,000 acre acquisition of leasehold and exploration activity
on those leases, and they have shot two very substantial 3D
programs. In this last week they drilled two very expensive
exploration wells at Smith Bay on their Tulimaniq Project.
9:04:45 AM
"On the bright side," Mr. Foley said, Caelus produced about
18,000 barrels of oil at Oooguruk yesterday and over the next
month they will complete stimulation activities on all the
wells, so that production will grow to over 20,000 barrels/day.
Then production will deplete normally over the next 30 years.
He said the results from the two wells at Smith Bay are very
encouraging and they plan to be out there next winter to
continue with an appraisal program. He hopes to be able to tell
them about development plans at some point in the future.
"On a significantly less bright side," in response to the low
oil price and tax uncertainty, Mr. Foley said, Caelus has been
forced to make very immediate and drastic changes to business
operations and last week announced suspension of drilling "grass
roots" wells at Oooguruk. This means that their Nabors 19 AC
drilling rig that has been drilling 365 days a year since 2008
will cease. That project employs nearly 300 contractors and
those jobs will be temporarily, he hopes, put on the shelf. In
addition, they will lay off nearly 25 percent of their workforce
next week. The Nuna Project remains on hold.
Simply put, Mr. Foley said, Caelus is struggling to survive and
this is probably the story of many other oil companies in the
United States today. Survival uses a fairly common formula:
eliminate waste and reduce all the costs wherever possible. Now,
the only tools that remain available to them are a reduction in
their capital program and administrative expenses. Simply put,
they cut payroll. They will do these things and at the same time
maintain their wells and facilities and continue with the same
excellent AHFC program. They will just have to find a way to
accomplish their objectives with fewer people.
9:08:20 AM
MR. FOLEY said their business has been funded for the last
several years by combining all of their available cash with any
free cash flow that is available and all of their earned tax
credits. They take that money and drill wells. The reality is
that the company has limited capital and no excess revenue over
their costs at this time, and in the future if the tax credits
are reduced they will have even less capital. That is why they
decided to suspend drilling operations.
9:08:58 AM
SENATOR WIELECHOWSKI joined the committee.
MR. FOLEY said slide 6 demonstrated how the current legislation
would impact Caelus. It used today's pricing, $36 or $37/barrel
in 2016, and increased that to $52 over the next five years.
They tried to portray what their base business is and then
applied the various elements of the bill.
9:09:50 AM
SENATOR STEDMAN joined the committee.
MR. FOLEY continued that the GVR "fix" would no longer allow the
gross value reduction (GVR) to be included in the calculation of
a net operating loss (NOL). That simple piece actually erodes
the value of his business by about 13 percent and adding a 4
percent hard floor erodes the value of his business even more by
a total of 31 percent. A $25 million transferable credit limit
would erode the value of his business by 77 percent and raising
the hard floor to 5 percent would erode the value by 83 percent.
Then his business would be worth "17 cents on the dollar."
He also calculated the impacts of the bill that just came out of
the House. It used a 2 percent hard floor, a $100 million cap on
transferable tax credits, and limited the GVR applicability
period to 5 years. Its provisions are more favorable, but still
reduce the value of his business by nearly 50 percent.
The Nuna Project (slide 7) is the kind of project that is "on
the bubble," Mr. Foley said. It needs some price recovery in
order to go forward and it would also require some kind of a tax
credit system. But if it does go forward, it represents about
100 million barrels of oil and peak at production of 20-25,000
barrels/day. It would employ nearly 300 full-time employee
contractors for two years of construction and for about four or
five more years of a drilling program. That would result in
future royalty payments of nearly $900 million to the state and
future net profit share payments of $500 million. There would be
$250 million in future production tax payments and about $100
million in ad velorem tax payments.
MR. FOLEY said this project would be entitled to earn about $150
million in future NOL cash payments from the state. At today's
prices, this project won't go forward, but in the neighborhood
of $70/barrel it would. Then they would receive $250 million in
credits and that would be offset by future production tax
payments to the state in a similar amount. But over and above
that, the state would bring in nearly $1.5 billion in other
revenues.
9:14:34 AM
MR. FOLEY said he appreciates that the Alaska State Legislature
is in a fiscal crisis, like his company. Because of the economic
conditions his company faces, he will be reducing the payroll by
25 percent, but they would "find ways" to accomplish their
objectives with a smaller workforce. On Monday, he will have the
very unpleasant task of sitting across the table from very
smart, hardworking, caring, dedicated, hopeful people, many who
are his friends, and he will explain to them that in a matter of
days their employment will end. "And I can assure you that no
matter what side of that table you find yourself, it'll be
simply horrible..."
He said the oil industry has borne the vast majority of the
state's tax burden since the early development of Prudhoe Bay
and that may have been appropriate in the prosperous days of the
past, but those days are behind us now. The price has collapsed
by 70 percent in just this last year alone and at today's oil
price, his company loses money with every barrel it produces.
MR. FOLEY said there is a lot of talk about a need to diversify
revenue sources to help balance the budget and he advised that
it would be wise to seek a fair and balanced approach that takes
all the necessary measures to adequately protect the wellbeing
of the most vulnerable. Many of the tax credits contemplated in
the original bill attack the most vulnerable in industry, even
if they are oil companies.
9:18:12 AM
CHAIR GIESSEL noted that Senator Wielechowski and Senator
Stedman had joined the committee. She also noted that Deputy
Commissioner of DOR, Jerry Burnett, was in the audience.
SENATOR COSTELLO said she appreciated slide 6 that laid out how
the different components of the bill will impact his company and
asked him to comment on the logic that previous legislatures
have used to try to incentivize his and other companies'
activities, and now say they were successful and now it's
prudent to pull back on some of that because the state is facing
budget challenges.
MR. FOLEY responded that SB 21 found the right balance of tax
and credits. It was a simple bargain that said we're going to
help struggling new companies by offering tax credits upfront.
In exchange, those projects will generate royalties, production
tax, and in his case, net profit share payments, as well as
other payments to the state. So, SB 21 did exactly what it was
intended to do. It allowed Caelus to purchase the Pioneer
assets. The biggest driver that brought them to the state was
the tax credit system. Alaska has always been known for being a
high cost environment, but with tremendous rocks and tremendous
reservoir properties and the tax credit program helped balance
those costs.
9:21:21 AM
SENATOR COSTELLO asked how the investment community has
responded to this legislation.
MR. FOLEY answered that the investment community is "terrified."
They need favorable fiscal terms, but more than that, they need
stability and predictability. They need to know that the rules
in place when investment decisions were made will stay in place
for the life of a project. Pioneer came up in 2002 and Oooguruk
commenced production in 2008. So, they were "sort of born during
the ELF environment." There have been five or six significant
tax regime changes since then. Nowhere else on the planet
changes its fiscal policy so frequently. When the investment
community looks at that it gives them grave concern in making
future investments. You can't blame everything on the tax
policy, but along with the depressed oil price, it makes
attracting future investment "very, very difficult."
SENATOR COSTELLO asked the total government take at the Oooguruk
field.
MR. FOLEY answered that simply put, government take is a share
of the profits, as are the costs. The company take is what is
left over and at today's prices, he has no profits. His take is
zero. Government take could be described as 100 percent, meaning
they take royalty payment despite profitability. Property tax
payments are made despite profitability, as well - although that
is part of their contract. The issue today is that there are no
profits and the bill before them tries to take a greater piece
of the money that is available.
CHAIR GIESSEL said some folks assert that the rig being down and
layoffs would have happened for Caelus anyway in today's price
environment.
MR. FOLEY responded that there is an element of truth to that,
but the facts are that the price is horrible, Caelus is not
profitable and can't continue to make investments to drill
wells. To finance drilling of wells they take the cash they have
available and add future tax credits to that. As they lose
confidence that they are going to continue to receive and earn
those tax credits, their future forecasts for capital that would
be required to continue drilling wells is higher than it
otherwise would be with those tax credits.
9:25:24 AM
Their rig is idle, but hopefully, they will see price recovery
and be able to start it back up again. He didn't know the exact
price at which that would happen, but he did know that if
changes are made to the tax credit system and other elements of
the state's fiscal policy, the price required to restart goes
higher than it would otherwise be if the tax policy remained as
it is today.
CHAIR GIESSEL thanked him and asked if he had received a reply
to the letter he sent to the Governor.
MR. FOLEY replied that the letter was sent by Jim Musselman and
he was not aware of a reply.
SENATOR WIELECHOWSKI asked him if Alaska should be lowering its
taxes or providing more tax credits to keep companies like his
from leaving Alaska.
MR. FOLEY answered that he believes the balance found in SB 21
is appropriate. Caelus was able to drill two exploration wells
out in Smith Bay under it, which also earned exploration
incentive credits (EIC). It is also a program that will sunset.
He appreciates that it costs the state money to fund the credits
earned for exploration, but he also believes more wells were
drilled because of those credits. If those go away, he suspected
there would be less exploration activity in the future.
SENATOR WIELECHOWSKI asked if it's appropriate for the state to
take more than 100 percent (that Mr. Foley had testified it was
taking under the current tax structure).
MR. FOLEY answered no.
SENATOR WIELECHOWSKI asked if he was saying in order to change
that, the tax needs to be lowered.
MR. FOLEY answered under today's price Caelus make no profits.
Hopefully, the price will go up and they will again make
profits. They made previous investment decisions under SB 21
rules and they would continue making those investment decisions.
SENATOR WIELECHOWSKI asked what percentage of the exploratory
work was paid to Caelus with state tax credits.
MR. FOLEY answered that tax credits haven't been paid for
anything yet. The work has been done and all of the bills have
been paid by Caelus; that work enabled them earn tax credits
which they have not received. Specifically, Caelus has earned
two forms of tax credits: NOL and EIC credits, and the
combination of those two equals nearly 75 percent of their
costs.
SENATOR WIELECHOWSKI asked if any other oil jurisdictions in the
world provide 75 percent in tax credits incentives.
MR. FOLEY answered no, but the bargain struck under SB 21
offered credits up front in exchange for a bigger piece of the
profits down the road. If there is no project, there are no
profits.
9:29:57 AM
SENATOR WIELECHOWSKI said the director of the Tax Division
testified earlier that the state wouldn't receive more in
production taxes than it is paying in tax credits until 2025 and
asked if Caelus received any royalty relief in any of its
projects.
MR. FOLEY answered yes; their Oooguruk project enjoyed royalty
relief. It is one of the highest royalty and NPSL projects on
the North Slope. He explained that royalty modification
basically encourages a project to go forward by improving the
economics. Pioneer was encouraged at the time to make its
original investments with a flat 5 percent royalty until the
project became profitable.
As to the second question about credits being greater than the
state's revenues, and the point he tried to make with slide 7 is
that there is coincidentally an absolute balance between the
credits that are earned by the Nuna project and the future
production tax payments. But production tax is not the only
revenue that the state gets; it also gets nearly $1 billion in
royalty payments and about $.5 billion in net profit share
payments.
SENATOR WIELECHOWSKI asked if any of Caelus' projects are
eligible for the GVR, which reduces the production tax down to
zero.
MR. FOLEY replied that the Oooguruk field qualifies for a 20
percent GVR reduction that allows them to eliminate 20 percent
of the revenue in the calculation of their tax bill and NOL. In
this instance he is not yet profitable, so he does not pay a
production tax. The GVR doesn't necessarily mean that each and
every GVR field would not pay a production tax.
SENATOR WIELECHOWSKI said the State of Alaska paid 75 percent of
their exploration costs and asked what percent of the
development costs the state picked up through development
credits and deductions.
MR. FOLEY answered that it is a matter of semantics, but no one
has paid 75 percent of the costs. Caelus paid 100 percent of the
cost and that work will earn them credits, but they don't have
them now. Tulimaniq wasn't an exploration project and is not in
development. Oooguruk is a field that does have a net operating
loss and it does earn NOL credits. He reminded them that Pioneer
came to Alaska in 2002 and spent $2 billion and the project has
yet to make a profit. So, they are in a net operating loss
position. Some people may ask how they can have been here for so
long and still not make a profit - they must not be very good.
The reality is under the production tax system the net operating
loss simply means that they spend more money in the state than
they bring in. That is typical of any new growing business where
all your money is plowed back into future capital projects, and
down the road they will become profitable. And down the road
Caelus would pay a production tax.
9:35:16 AM
SENATOR WIELECHOWSKI asked if the state were to make no changes
to its oil tax structure or the tax credit system, would he
commit to reverse his decision to cut the workforce and cut back
on some of their drilling.
MR. FOLEY answered that price of oil forced them to make that
decision, but they hope for price recovery, and if the tax
system becomes less favorable, it will take a higher price in
the future for them to resume drilling activities.
SENATOR WIELECHOWSKI asked if they did nothing to the tax
structure this year, would he stay in Alaska and keep current
work levels as they are.
MR. FOLEY answered that Caelus has no plans to leave Alaska and
will continue to produce the Oooguruk field, but they are not
able to make continued capital investment. So, the real question
is if the tax laws stayed the same, would they continue to make
capital investments, and the answer is that they still need
price recovery. But if the tax law changes the price has to
recover to a higher level.
9:37:26 AM
SENATOR MICCICHE said the second page of Caelus' letter to the
governor talks about the constant barrage of anti-industry
rhetoric, but those that worked on the current tax regime are
also under attack. "So, we get it." For some reason some folks
just don't like the oil industry and that's just the reality.
They like some larger companies that provide them products that
perhaps are optional, but they strongly dislike energy companies
that provide products that are necessary.
The letter says the state is struggling to evaluate its entire
fiscal system right now, because it has a problem called the
$4.1 billion fiscal gap. He didn't like the "wiser heads in
Juneau" comment. He found it offensive. He advised that as the
legislature struggles through this problem, for people to
provide helpful comments on some of the ways the state could
better manage its way through a low price environment.
SENATOR MICCICHE noted the slide that says "Nuna, A Project on
the Bubble" could have said "The Energy Industry, a Sector on
the Bubble," because every member in that sector is feeling the
pain right now and Mr. Foley had clarified that their decisions
were based largely on the economics.
SENATOR MICCICHE said he had personally sat in on some very
painful discussions over the last year and a half with industry
and he has always counted the State of Alaska as a partner,
because it is "our economy." Unfortunately, the state is not
diversified and is very dependent on the revenue that comes from
oil and gas. He concluded that he would love to see a letter
with some suggestions on how to manage through a low price
environment and that he had asked the state's industry partners
for the same. He would love to hear from them, but hasn't had a
response.
What he gets from the Musselman letter is that the legislature
and perhaps the administration has been largely irresponsible on
some of their decisions, and he would like to see that turned
around to: "If I were in your position, being an industry
expert, what I would suggest is that you look at some of these
suggestions."
9:41:12 AM
SENATOR MICCICHE said most of U.S. oil is just trying to manage
its way through a very low price environment and hoping for an
improvement in the future. He thought Mr. Foley would agree with
that. He asked if Caelus has any production that looks different
than slide 5 right now.
MR. FOLEY replied that Oooguruk is the only field that Caelus
operates in Alaska and right now Alaska is the only place they
operate. Senator Micciche is exactly correct, the whole industry
is struggling whether they are in Alaska or the Lower 48. He
uses his company as an example of all of the newer smaller
companies, but in reality none of the companies are profitable
at today's oil prices.
In response to Senator Micciche's comment about industry coming
forward with suggestions, Mr. Foley said he was invited to
testify as an expert in the oil industry, and his point is that
the oil industry doesn't have any excess profits to give. They
are struggling for survival just like the State of Alaska.
SENATOR MICCICHE said that was fair and he agrees. However, some
suggestions might be ideas on how to manage through a low price
environment together and ways that might soften the effect on
the general fund when things are improved. Think about it that
way, he advised; these are tough decisions.
CHAIR GIESSEL thanked Mr. Foley for his testimony.
SENATOR WIELECHOWSKI said Caelus alleged that there is a
constant barrage of anti-industry rhetoric and asked if Mr.
Musselman or Mr. Foley could provide a list of the constant
barrage of anti-industry rhetoric in writing.
CHAIR GIESSEL supported the request and asked Mr. Foley to
submit that request in writing. She then invited Mr. Bruce Webb
from Furie Alaska to testify.
9:46:18 AM
BRUCE WEBB, Sr. Vice President, Furie Operating Alaska LLC,
Anchorage, Alaska, said Furie took over leases from Escopeta Oil
Company in 2010, and with the State of Alaska as partner, they
went down the road of putting in a new development in the Cook
Inlet. For the last five years they have drilled five
exploration wells; one was converted to a development well on
their new platform. They have also put in about 16 miles of sub-
sea pipeline and a new processing facility.
Prior to 2015, they had spent about a half billion dollars, and
last year alone, they spent $200 million to put the
infrastructure in place. They employed about 300 Alaskans during
that project. They are very proud of the two gas contracts that
give them a brighter future. When they started this they had no
gas contracts and no way to repay their debt. Furie is here for
the long run, he said. Some companies have gone bankrupt and a
couple large companies decided to leave Cook Inlet, but Furie
decided to stay. They view the State of Alaska as a partner and
hope they continue their partnership into the future.
9:48:12 AM
MR. WEBB said the tax credits are very important to the oil
industry; they provide investments and jobs to Alaskans and
supply revenue to the state. He explained that because Furie is
in Cook Inlet it doesn't pay production tax, but they do pay
lease rentals and royalties, property tax and other payments
that directly benefit the state. They have already invested $700
million and have employed 300 people in Alaska. Their utility
contracts have begun to reduce energy costs in the Cook Inlet.
He pointed out that 100 percent of every tax credit
reimbursement Furie gets is reinvested directly into their
project. None of the tax credit money has left Alaska. Without
the tax credits Furie will have to significantly reduce their
exploration and development that will ultimately result in the
reduction of jobs. He showed a couple pictures of their onshore
facility at Nikiski and the offshore platform. He reiterated
that they had lowered the price of energy in Cook Inlet and have
increased revenues to the state of Alaska, as well as adding new
jobs. The tax credit lowers the risk of shortfalls of natural
gas in the future and it may be short-sighted to end that 15-20
year supply of natural gas right now or they may be back to
where they were in 2008/9.
9:50:46 AM
He had heard that Cook Inlet benefits only the people around
Cook Inlet, but that is not correct. Everything that goes to all
the communities in Alaska comes through Anchorage. Cook Inlet
has what is called sweet light crude; it is taken to the local
refinery and turned into gasoline, diesel fuel, jet fuel,
heating oil and propane. This local energy reduces the cost of
transportation of everything: food, building materials,
automobiles, and everything that is shipped to the villages.
In March 2014, the Chamber of Commerce commissioned a study with
Northern Economics that concluded that Cook Inlet oil and gas
production directly benefits the rest of the state to the tune
of $2.4 billion. So, for people who say otherwise, it's just not
correct. Without the lowered transportation costs, everything in
all the other villages and communities would be more expensive.
MR. WEBB said the current tax credit program as it exists today
is crucial to their business. They use the 20 percent qualified
capital expenditure, the $25 million carry forward loss, and the
40 percent lease operating costs. Without this tax credit
structure, Furie would not have been able to make it in the Cook
Inlet. The price of doing business there is about three times
higher than anywhere else in the United States, and add the
offshore environment to that where you can only drill six months
out of the year and must pay for storage the other six months.
The upside is that the resource is larger. So, there is the
prospect of being profitable in the future and they hope to see
a profit under the current tax structure until 2018 when the
Enstar natural gas contract comes into effect.
During the peak of construction last year, Mr. Webb stated,
Furie employed 300 people. They paid $2.9 million in property
taxes to the state, cities, and borough in 2012-2015. Those same
payments this year are going to be in the neighborhood of $4.8
to $5 million. So, local communities are already seeing an
increase of income. The lease rentals paid to the state since
2011 are $1.6 million; estimated royalties are about $300
million for the life of the project under the current reserves
if they don't develop any more. He provided a "short list" of
100 local businesses they supported during this project.
In terms of lowering energy costs, Homer Electric (supplying
30,000 customers in the Kenai Peninsula), stuck with them
through the entire process. When they started the development,
Hilcorp had absorbed the whole gas market. The attorney general
instituted what was called "consent decree pricing." Their
contract with Homer Electric started just a few days ago and now
Furie supplies all the gas for the Kenai Peninsula. In 2018,
those costs will decrease by about 16 percent over what they
would have been had Furie not been in the Cook Inlet. Just
recently, they signed the Enstar contract, which will decrease
energy costs by 17 percent to Cook Inlet and the Railbelt
communities. That isn't just Furie, though; the Chugach/Hilcorp
contract in 2018 will decrease energy costs by 8 percent. That
is because Hilcorp now has competition. Across the board, energy
prices in Cook Inlet will go down as will the transportation
costs to other communities in Alaska.
MR. WEBB said the tax credits were put in place for them to do
what they have done. But they are not done yet. With the $200
million Furie has invested, the State of Alaska is a partner
that will be going down this road with them. The tax credits are
like energy bars, and occasionally the state gives them an
energy bar and says keep going. Taking those energy bars away
will slow things down a lot. "We're still going to make it over
the finish line, but we're just not going to be running as
fast."
MR. WEBB had some general comments: Furie sympathizes with the
situation the state is in with budget deficit and hopes to work
out a good compromise. They think CSHB 245 is a good solution;
it would be like the state not giving them as many energy bars.
Saying, "Hey, we have to cut back; slow down your pace; conserve
your energy. We'll help you get over the line." But, if you
just take them away it will be devastating to the entire
industry.
9:56:36 AM
MR. WEBB explained the process behind their low cost capital
structure. He said they go to Wall Street and talk to banks like
Bank of America and ING, and finance the tax credits. The
certainty of the tax credits and their historic performance has
brought their cost of capital down from 17 percent to 5 or 6
percent. Before the governor's veto of the $200 million tax
credit appropriation last year, companies were financing 90 to
95 percent of the tax credit's face value at an interest rate of
5-7 percent. Recently these same companies are willing to
finance only 50 percent of the tax credit certificate at 17-20
percent. It's a huge difference. That money is received upfront
and provides them the liquidity to invest in a project. Then
they get the tax credit and pay it back. It's a constant, fluid
motion of money coming in and going out of the company.
SENATOR STEDMAN asked if a finer distinction could be made on
the credits' effect on their cost of debt, not their cost of
capital.
MR. WEBB answered yes.
SENATOR STEDMAN said normally a 20 percent capital credit is
offset with some tax collection mechanism. So, it looks like an
imbalance in Cook Inlet where they have left the capital credit
in place but there is no viable mechanism for the severance tax
portion to do the offset.
MR. WEBB responded that Furie doesn't pay severance tax on oil
or gas production under the current tax regime, and they are not
opposed to paying their fair share. However, they do pay the
royalties, which are much more significant than the property tax
would be. Their cost of capital has gone down and with the
sunsetting of this project at the point of paying off all their
debt, the prospect of paying tax in the future isn't exactly a
negative.
SENATOR MICCICHE asked for a couple-sentence description of how
the 2015 credit veto affected Furie.
MR. WEBB recalled that he was in Kenai for an economic forum
when the governor vetoed the credit appropriation and a lot of
cellphones started ringing, not just his. The reaction was
immediate: Wall Street and European investors were calling the
owners and CFOs to find out what was going on. That veto sent a
ripple across the finance world that immediately started pulling
back funds and looking at higher interest rates. Their comments
were the worst thing they can deal with is instability.
SENATOR MICCICHE said, "We're proud to have you there, and I
definitely believe a deal is a deal. We need to have clear-cut
policy going forward and not provide a game changer in the
middle of the season...Thanks for being there. We're excited
about what you are doing."
10:01:28 AM
SENATOR STEDMAN said the legislature can make additional
appropriations into that credit fund and asked Mr. Webb how he
thought the state could handle funding the credits to control
their impact on the treasury. Should we have open-ended
appropriations? Should we follow the appropriation cap language,
which is currently at $73 million?
MR. WEBB responded that the state is in a tough spot, but the
industry needs stability. It makes raising additional debt or
equity much easier. The $25 million cap in the bill is not
enough for Cook Inlet or his company. He would like to see a
$100-200 million range, something that they know will be there
and will be enough to get through 2016 and into 2017. Once that
happens, a reduction in the amount of the tax credits is
something they can plan for. Time is needed for planning; abrupt
change is hard to adapt to.
SENATOR STEDMAN said the cap is calculated off of the gross
production tax revenue and they are in the minimum tax arena.
Somebody has to pay it just to get the calculation to work. But
tying the credits to the revenue side from a policy perspective
also works together in a system. His concern was that some
delinking is going on that is creating some instability. The
state is in a very peculiar position.
10:05:36 AM
MR. WEBB said in the past there has always been a special
appropriation, and it would be nice to continue that. He would
ask his CFO to write a response with suggestions. "He's a pretty
sharp guy."
SENATOR STEDMAN said he thought that would be a good policy
discussion to have at the table, because in the minimum tax
arena the whole concept of the tax formula gets turned upside
down.
CHAIR GIESSEL said that formula is based on production taxes
coming from another basin and asked his thoughts on a production
tax for Cook Inlet noting that the House Finance Committee
Substitute had a 35 percent production tax for Cook Inlet
incorporated into it.
MR. WEBB answered that he thought Caelus could manage that if it
becomes effective in 2017, so it could be planned for.
CHAIR GIESSEL thanked him for testifying today and invited Mr.
Cook to testify.
10:07:51 AM
CHRIS COOK, Director, Finance, Ahtna, Incorporated, Anchorage,
Alaska, said Ahtna is using AS 43.55.025(a) tax credits - the
Frontier Basin tax credits and Middle Earth tax credits -
currently to explore the Copper River Basin. Ahtna would not be
doing that exploration if these incentives were not available
due to the high risks of exploration and financial risks.
He said their current drill site is on state land. The upside
for the state for this activity is royalty and production taxes,
lower rural energy costs, and community and economic development
in the Ahtna region. The purpose and need for gas in the Copper
River Basin is to develop and produce energy for local residents
and utilities by conducting exploration in the basin which
includes drilling the Tolsona 1 in the next several months and
potentially future targets in the area. He said Ahtna hopes to
be able to reduce the cost of energy in the area and that would
encourage business and therefore, reduce out-migration of the
population. They also hope to build infrastructure in the
region.
10:10:44 AM
Ahtna has drilled 11 exploration wells since the 1960s in the
Copper River Basin. The most recent well was drilled by Rutter
in 2005 and then they came back in 2008. So, there is a
potential for energy exploration and production in that area.
10:11:13 AM
MR. COOK said Ahtna's originally acquired some Amoco seismic and
over the last several years has been working their exploration
program off of that. Ahtna has submitted its data to the DNR and
obtained prequalification to utilize the 025 tax credits. Their
seismic program has targeted drilling the Tolsona 1 in the next
several months on state land. The site is about 10 miles outside
of Glennallen heading toward Anchorage; the pad is being
installed now. A road is being built that will be also be used
for public access to the Crosswind Lakes Trail. He explained
that the well is expected to be about 4500 vertical feet deep
and targets the Nelchina sandstone. They have had natural gas
shows in nearby wells, which indicates a great potential for a
local fuel source.
10:12:46 AM
MR. COOK said the Tolsona 1 project team is 100 percent Ahtna.
Although Ahtna prefers having good partners to work with, their
partners with Copper River Basin experience are not able to
participate in this well due to low energy prices (slide 8). The
Tolsona Exploration Oil and Gas Company has a lot of Alaskan
companies working for it: Ahtna Construction is putting in the
pad right now; Restoration Science and Engineering is working on
permitting; HXR Drilling Services is doing the well engineering;
Michael L. Foster Group companies are providing some of the
services; and many state, local and federal agencies are
supporting them in getting the well ready to go. As an example,
the DNR Division of Oil and Gas director has visited the region
and the project site.
10:14:02 AM
MR. COOK concluded with their request: to extend 025(6)(a) and
(7) tax credits from July 2, 2016 to July 1, 2022, similar to
other tax credit expiration dates. Ahtna also supports keeping
the 023 and 025 (a)(1-4) Middle Earth tax credits in place as
incentive to explore and develop energy in that region. He
thanked the committee, the Alaska Legislature, the Governor and
his staff, and the citizens of Alaska for their support.
10:15:04 AM
SENATOR WIELECHOWSKI asked if their exploration is targeting oil
or gas.
MR. COOK answered that it is targeting gas.
CHAIR GIESSEL finding no further questions, thanked Mr. Cook and
invited Mr. Galvin to testify.
10:15:23 AM
PAT GALVIN, Chief Commercial Officer and General Counsel, Great
Bear Petroleum, Anchorage, Alaska, related a quick history of
the company (slides 2-3) and then talked about their project and
how the state tax credit program affects it. He said Great Bear
was founded in 2010 when it picked up almost 500,000 acres of
oil and gas leases just below Prudhoe Bay and Kuparuk. They are
exclusively focused on Alaska's North Slope and have offices in
Anchorage; all of their employees work and live in Anchorage.
They currently hold the original acres, but have brought in
additional partners that has raised the total area to 590,000
acres. They have acquired 500 square miles of 3D seismic over
the last four winters and are currently acquiring another 450
square miles of seismic. They have drilled three exploration
wells.
He said the Great Bear story really starts with the shale play
and the idea that the North Slope has tremendous opportunity,
because of prolific shale intervals that are stacked on top of
each other. The expectation is that those can serve as a source
for the kind of shale play that has been successfully developed
in basins in the Lower 48.
Great Bear drilled its first two wells with the intent of
pursuing that type of a play, but discovered that the 2010-2014
cost structure on the North Slope would prohibit that type of
development. Then the question became how to get the initial
investment in infrastructure in place in order to make such a
project economic. Fortunately, during that time they were able
to acquire the 3D seismic which allowed them to identify
conventional plays for a development project that would support
the infrastructure capital costs thus laying the infrastructure
for the future shale play. They still believe that a shale play
is a potential in the long term on the North Slope, but it will
have to be built upon the foundation of a series of conventional
plays.
MR. GALVIN said with that transition, the Great Bear
organization significantly changed its management team and
expanded its geoscience and technical capabilities. They
analyzed the seismic data and developed a prospect inventory
that increased their confidence where even in the current low
price environment they saw opportunity.
10:20:47 AM
He said the management team was expanded to include operations
expertise that it previously did not have; their new CEO and
president, Mike Mason, is a petroleum engineer and has a long
history and career of drilling throughout the world. At one
point he was the top petroleum engineer at BP. He ran Apache's
Egypt operations immediately before coming to Great Bear.
The Chief Operating Officer is Clark Clement who is one of the
leaders in hydraulic fracturing. He has drilled all over the
world and has significant experience in developing new
technologies and unlocking the potential in different fields.
MR. GALVIN said their acreage sits due south of Prudhoe Bay and
Kuparuk; Dead Horse sits just above them. The TransAlaska
Pipeline (TAPS) and the Dalton Highway cut right through it
providing a significant advantage as an established
transportation corridor. Earlier, Great Bear formed a strategic
partnership with Halliburton that became a 25 percent working
interest owner of the leases and paid for the first two wells
and some seismic. Recently, they struck a deal with Borealis
that was subsequently purchased by Otto Energy, an Australian
publically traded company that purchased an 8-10 percent working
interest in most of their leasehold in order to bring them below
the acreage limit.
MR. GALVIN explained that there are three primary shale or
source rock intervals on the North Slope and they are all
present within Great Bear's leasehold. Most recently there has
been a lot of talk about the QHRZ, because of the Icewine well
that has been drilled just to the south of their acreage. That
is one of the potential source rock intervals Great Bear is
looking at.
The Shublik is considered to be potentially the most prolific of
the source rock intervals. With the 3D seismic and the wells
they have drilled, they have also identified reservoir rock that
has been produced elsewhere on the North Slope present on their
acreage as well. Those sit nested between the source rock
intervals, which is an ideal situation. Their objective is to
look somewhere between a conventional and an unconventional play
within these various nested rock intervals and find out where
the oil may be trapped and where it may be producible given
particular rock properties.
The bright line terms for conventional versus unconventional
have really been blurred over the last decade or so, he said,
with new technologies being used on a more conventional basis.
The particular reservoir properties they are looking for have
shifted significantly over that time and have created
opportunities to develop fields that previously would have been
considered uneconomic.
10:25:05 AM
MR. GALVIN said that Great Bear sees the opportunity to use
unconventional technology (horizontal drilling and hydraulic
fracturing) to develop a range of fields that would be
considered somewhere between conventional and unconventional.
10:25:31 AM
SENATOR COGHILL joined the committee.
10:25:48 AM
MR. GALVIN said slides 8 and 9 were a representation of the
modeling that had been done previously on the North Slope as the
oil is produced towards the south in the source intervals and
then migrates north into the fields that are currently being
produced. It recognizes that most of the oil being produced out
of Prudhoe Bay and Kuparuk actually originated south of their
acreage and has migrated over the millennia into their current
fields. The Great Bear concept recognizes that this oil has
moved through their area or was produced under it and goes back
to the source and to see if it can be produced there. Because
most of the time, oil remains trapped within the reservoir or
the first rocks that created it. Also, there are likely traps
along the way where the oil has pooled, another opportunity to
produce.
10:26:54 AM
He said Great Bear has spent four winters shooting seismic and
has acquired 500 square miles across the center portion of their
acreage position. This winter they have completed the western
block and are currently shooting the eastern block with hopes of
completion before the season ends. Once this is in hand, they
will have a complete inventory across their primary contiguous
acreage, a significant tool for identifying conventional
prospects.
In 2012, Mr. Galvin said, they drilled two wells along the Haul
Road and permitted six sites that are all adjacent to gravel
access roads to TAPS, which means the sites can be accessed
year-round (slide 10). The Alcor and Merak wells were drilled in
the summer of 2012 primarily to test the shale intervals and to
pull whole core samples from them to provide significant
information about the shale play opportunities. Subsequently,
using 3D seismic they were able to identify conventional targets
and drilled the Alkaid well about 3.5 miles west of the Haul
Road on an ice pad in the winter of 2015. They were hoping to
drill two other sites that winter, but the short season as well
as operational issues precluded that and they were only able to
complete the one well.
10:28:32 AM
Going forward (slide 11), he said that Great Bear plans to
complete their seismic program this year and develop a priority
list of prospects that will be drillable and ready to pursue.
They will execute a multi-year, multi-well exploration program
to pursue those conventional prospects. And through that they
hope to achieve more cost-effective services in the exploration
side.
10:29:06 AM
He said there are four myths about how the North Slope
exploration works in that environment and the tax credit issue.
1. That exploration companies are "financed" by Alaska tax
credits.
2. That exploration companies don't have skin in the game on
these exploration plays.
3. That Alaska could get the same level of exploration activity
with lower exploration tax credits.
4. That tax credit payments can be delayed with little impact to
exploration companies.
10:30:22 AM
MR. GALVIN said the truth is that companies have to actually
spend the money up front to be eligible for the tax credits.
They will pay for their employees, their offices, all their
rentals, and all of their contractors, and then some of those
expenditures will be eligible for tax credits in different
amounts. Great Bear's seismic activities between the EIC and NOL
programs are potentially eligible for up to 75 percent credit
this year. It will drop to 35 percent in June 2016.
He explained that an explorer can currently borrow on the
expectation of getting those tax credit payments back from the
state. That's really the only borrowing that an exploration
company can do, because it's the one certain cash flow coming
back from the operation. Exploration companies have a better
than 50/50 chance of not seeing any cash flow from their
exploration expenditures and no one will lend money on that.
Money is borrowed only through having equity.
10:31:51 AM
At no time does an exploration company make money off of
exploration activities in Alaska, at least as it relates to tax
credit reimbursement from the state, Mr. Galvin said.
SENATOR STEDMAN said Mr. Galvin was in kind of a unique position
being an ex-commissioner of the Department of Revenue (DOR),
understanding the politics of the building, and having his
current background. So he has a pretty good feel for what they
are struggling with on both sides of the table in trying to meet
payrolls and financing the credits with open-ended
appropriations versus the appropriation cap mechanism that
impacts industry and exposes the treasury, and he was wondering
if he had any comments on that particular issue.
MR. GALVIN responded that he disagreed with the characterization
of the statutory language as a "cap." It was never intended to
be a cap in any way. It was intended to basically be a flow of
automatic money that would go into the fund in order for it to
be legally recognized as a source of funds from the state. The
expectation throughout the development of the tax credit fund
was that there would be annual appropriations based upon what
the expected cash flow obligations of the state to that fund
would be. Almost immediately it was set up as an open-ended
appropriation in order to forestall the risk that the state
would not be able to meet the obligations of a credit
certificate being submitted to it for reimbursement.
10:34:41 AM
He explained that the reimbursable tax credit program was always
seen as a cash flow obligation of the state and it was expected
to be part of the cash flow structure in terms of the plan the
state would develop in order to meet its obligation. Right now
with the low oil price, the state is in a significant cash flow
challenge, but "it is just that: a cash flow challenge," he
said.
MR. GALVIN said he had testified a number of times with regard
to the oil production tax, that the expectation was at high oil
prices the state would sock away the surplus in order to be able
to meet its obligations during the times of low oil prices. The
state is dependent upon a cyclically priced commodity and it has
to plan accordingly. This happens to be one of the most extreme
periods of having to meet that obligation.
SENATOR WIELECHOWSKI said the original ACES legislation had a
lower progressivity than the ultimate ACES: a 25 percent tax
rate and .2 percent progressivity after $30, but it also had a
10 percent floor for legacy fields. As the bill negotiated its
way through the process, the producers said they had to get rid
of the 10 percent floor, which they did. But they increased the
progressivity at the high end, too, to .4 percent. Now, they've
taken away the progressivity at the high end and have decreased
the floor to 4 percent, which can go below zero. He asked Mr.
Galvin if he thinks it was appropriate at the time and is it
appropriate now to have a 10 percent floor on legacy fields.
10:38:00 AM
MR. GALVIN replied he had testified a number of times on behalf
of the Palin administration that the state accepted the
elimination of the floor solely because of the addition of the
progressivity; it was a trade-off. Elimination of the 10 percent
floor resulted in basically falling back to the previous floor
that existed; it wasn't putting a new floor in. That was seen at
the time as the appropriate deal for that legislative session.
SENATOR WIELECHOWSKI asked now that we no longer have the
progressivity levels that we had, would he agree that it's
appropriate to reconsider a higher floor. He recapped:
The way the deal works, we no longer have the
progressivity we had under ACES. The original deal was
we get a 10 percent floor, lower progressivity. Oil
companies said no we don't want that. We got the
higher progressivity; got rid of the floor for the
most part. Now that we've got rid of progressivity at
the high end like we had, it would seem appropriate
that we go back to a 10 percent floor on the legacy
fields.
MR. GALVIN responded that he understands the logic, and he had
accepted that trade-off in the early ACES structure as
legitimate, but now there are a number of different
considerations with regard to the tax system besides just those
two moving parts.
He said Great Bear and its partners had spent a total of $220
million on exploration activities and are eligible for and
expect to recover $140 million from the state in tax credit
payments. Great Bear investors had contributed $80 million that
will not be reimbursed. As an exploration company, none of the
tax credits go back to their investors; they are all put back
into the ground to do more exploration.
10:41:29 AM
This exploration is valuable to not only Great Bear but to the
state, because it is developing state resources. Their seismic
is immediately available to the state and will eventually be
available to the public after their lease term. The well data
goes straight to the state of Alaska and becomes public after
two years, as well. This is a tremendous resource for the state
in its ability to identify future oil to be produced. This is
important because there is a vast amount of oil that has not
been discovered on the North Slope and the only way the state
can get to it is to invest the money to acquire the information
to determine where it may be and where it may be economically
developed. So, the tax credits, particularly the exploration tax
credits, were a very conscious decision on the part of the
state's resource managers to try to incentivize the investment
in this exploration activity that is otherwise very risky.
10:43:00 AM
As to the question of whether or not lower tax credits will
still result in the same amount of activity, the truth is that
the decision making process for an exploration company just
doesn't work that way. As an example, he used a scenario where a
company like Great Bear has $100 million from investors willing
to put that into exploration activity. So, with the ability to
borrow on the tax credits they anticipate getting back from the
state (35 percent tax credits), they can plan for a $140 million
exploration program. Their equity money will pay for Great
Bear's portion of the well. The rest will be borrowed and be
paid back at the end of the day with the tax credit
reimbursement. A finance charge is associated with that and so a
bit of money goes out of the system to the financers, but the
rest of it goes into the ground.
If the state offers a 65 percent tax credit, then Great Bear's
exploration program is going to be $260 million, because of
their equity investment and borrowing against the tax credits
they earn through that expenditure. So, the tax credits on the
exploration side simply create a multiplier effect for how much
exploration activity is going to be generated by the investment
dollars that come from companies like Great Bear. Simply put, by
offering a higher tax credit, the state will generate more
exploration activity.
10:45:08 AM
To Senator Stedman's question, what happens when the state
changes the flow of cash back to the exploration company, he
said that if there is a delay in reimbursement but its
anticipated and spread out, it will just take on more of a
finance cost. More money in their budget will go to interest
payments on the borrowing against those tax credits and it will
likely be at a higher interest rate. If there is uncertainty or
surprises in the state's reimbursement, such as the governor's
veto, it increases the perspective of risk and basically scares
away potential lenders.
MR. GALVIN explained that the state has successfully attracted
much lower cost of debt capital on these tax credit financing
deals over the past three years - going from the high teens to
the single digits. That has resulted in a much greater amount of
the tax credit money going back into the exploration activity
itself, as opposed to going to finance costs.
If a pattern of uncertainty is created or a sense of
vulnerability of that cash flow coming from the state to pay for
the certificates, that will basically chase away the
conventional banks. Then companies will at best be able to
retain the private equity groups that were lending at high
interest rates. However, there is a good chance that even those
will be lost as well. If exploration companies are no longer
able to borrow against the tax credit reimbursement, the model
he described earlier completely changes. They end up with that
$100 million and have a $100 million exploration program,
because that's all the money they have. Eventually they would
get reimbursed from the state and would have to decide to pocket
that money or try to have another exploration program, and
somehow cobble together additional equity investment. The
uncertainty would both slow down and result in significantly
less exploration activity going forward than having steady
predictable payments that the companies can borrow against and
basically spend the tax credit before it comes back. From an
exploration side, that is what creates the multiplier.
10:48:38 AM
SENATOR STEDMAN asked him to elaborate on short funding or lack
of appropriations to pay full credits and how a company would
plan on getting them in 2016 or 17, or could they even plan on
getting them if they hypothetically still have 2015 credits on
the books.
MR. GALVIN replied going back to his earlier characterization
that the statutory language is truly perceived as a cap and the
amount of annual funding for the tax credit reimbursement was
set at that formulaic rate, then he could predict fairly
confidently that Great Bear would no longer be able to borrow
against the tax credits. The reason being that as an individual
borrower, they could not predict to their lender when they would
be reimbursed, because it would depend on multiple things
outside of their control: the oil price, the amount of
production tax the state is going to get, and the level of
credit applications the state receives from other potential
companies. "That level of uncertainty would pretty much dry up
any ability to borrow against the credits," he said.
10:50:45 AM
If the state institutes a cap at an individual company level,
similar to what is being proposed now, that would be manageable,
because it would be a "predictable delay." The question is at
what level it gets set: the lower the level, the more expensive
the debt will be. More money will go to lenders and less will go
into the actual exploration activity.
SENATOR WIELECHOWSKI said he appreciates Great Bear's work, but
he was on this committee five years ago when Great Bear talked
about how they would see 1 million barrels a day within 10
years. The state has now invested $140 million and is hoping
they see some production, but it seems that Great Bear has
abandoned unconventional production and is now focusing on
conventional, which won't get them anywhere near what they had
initially said years ago. He asked from the big picture
perspective, which is what they have to manage, how he can, as
the former Revenue commissioner, have supported a system that
had the state paying out more in oil tax credits than it gets in
production taxes for a decade. The state won't be revenue
positive from a production tax perspective until the end of
2024.
10:53:38 AM
MR. GALVIN answered that it's important to separate the
different tax credits from each other. There is a difference
between the North Slope cash flow and the Cook Inlet cash flow.
On the North Slope different cash flows are associated with
exploration, development projects, and with production.
Exploration is probably the lowest of the cash outflow from the
state in terms of that system, because development is what sucks
up a lot of investment and creates a significant amount of tax
credit eligibility. Their analysis needs to split those up and
not just paint it all with one broad brush.
Great Bear truly believes tax credits still remain a very
valuable investment for Alaska. Continuing the EIC credit would
be a good investment, as well, because those are providing
tangible benefits back to the state in the form of exploration
data that the state needs in order to develop its resources in
the future.
MR. GALVIN said while it's true that Great Bear was here five
years ago talking about the shale play, they have not abandoned
the concept of the shale play; the prize is still there. They
just believe they have to take a different route to get there by
doing a conventional play first in order to establish the
economic framework that a shale play can work from.
10:56:05 AM
To Senator Wielechowski's overarching point that the state is
not going to see any positive cash flow from production tax, he
had not spent a lot of time looking at the modeling that results
in that conclusion, but it is something he questions in the
sense that there are multiple variables and there is a big
question with regard to behavior. If the low price environment
continues on for that decade and results in low production tax,
the state will simultaneously see significant reductions in
expenditures from the companies, which paying out significantly
less credits. So, there is a certain aspect of self-correction
to the system.
MR. GALVIN said they had dropped into this exceptionally low
price environment at such a rapid rate that a lot are hoping to
come out of it and just continue to move forward. But as
companies, like Caelus, begin to deal with that and begin to
lower their capital expenditures, then the state's credit
responsibilities are going to shrink, as well. Having been
through a big drop and rise in oil prices, he still expects oil
prices to come back up again, and whatever modeling Senator
Wielechowski is looking at is going to prove to be as full of
errors as Great Bear's was when he was commissioner.
He advised that a clear balance has to be struck, but it's not
something one could broadly brush; you have to look at the
component parts.
10:59:05 AM
He added that the state had invested significant policy and
money in and attempted to help the natural evolution of the
North Slope from being dominated by just a few players to having
a diverse group of independents who will not only create new
production, but also create a new economy that will bring down
costs and create a more cost effective way of producing fields
that currently may not look economic. That effort has worked.
The landscape has changed significantly on the North Slope in
terms of the players and the economy.
He noted that momentum is an extremely strong force in the
industry. It took a long time to get folks to recognize that
they had moved to a net profits based system and to move past
some of their beliefs about the State of Alaska. The biggest
risk continues to be the sense that the oil fiscal system is a
ping pong ball that will continue to bounce back and forth as
the political winds swing. A way has to be found through some
form of a compromise to reach a sense of stability. Without it,
there will be continued reluctance to come full force into
Alaska.
SENATOR WIELECHOWSKI asked if Great Bear were to produce new oil
would it be considered new oil and be eligible for the new oil
provisions of SB 21.
MR. GALVIN answered yes; everything they have would be
considered new oil.
SENATOR WIELECHOWSKI pointed out this fundamental problem: that
the state has invested $140 million in Great Bear that "took
advantage of all the incredibly generous tax credits." And while
he did not criticize them for doing that, they will also be able
to take advantage of all the incredible tax benefits (GVR
exclusion and a tremendous cut in production taxes) provided
under SB 21, because their production will be considered new
oil. His expectation is, since it probably has high expenses, if
they ultimately go on line that the state will see virtually
nothing in production taxes from any oil that Great Bear
produces.
MR. GALVIN responded that a lot of modeling will have to go into
the assumption of how much the state will get from Great Bear
production. He would describe it in a slightly different way:
that as an exploration company, they are hoping to make a
discovery. If they do, they will have to evaluate whether or not
it is economic enough to invest with development costs.
Depending upon the tax system the state has in place and that
they expect to be in place as they move into production, Great
Bear will make that decision. It will establish the hurdle that
they have to overcome in order "greenlight" that project.
If the state choses to change that economic system between now
and their discovery, then it will simply change that hurdle, and
may preclude Great Bear from developing something that they
otherwise would develop. That is the risk the state is taking;
that is the choice the body is making in terms of setting this
oil fiscal system. The state needs to know where that line
should be drawn in order to properly balance the state's desire
for a share of that revenue with the desire for more lights to
turn green on these development projects. From Great Bear's
perspective, the legislature gets to make that call.
MR. GALVIN explained that Great Bear is in a favorable position
today, because they haven't already made a decision and aren't
already half-way through a development project. His concern and
request was that "you find that equilibrium point soon and
provide a stable environment for a generation of oil and gas
activity that I believe is still available on the North Slope."
11:04:29 AM
SENATOR STEDMAN asked what he thought about the $5/barrel credit
for the GVR that goes below the floor - $75 million going
against a floor of $182 million. The new oil would eventually
grow with the decay of the other fields and take out the entire
minimum tax if they don't take out the minimum floor.
MR. GALVIN responded that from his perspective he hoped when
Great Bear is in production they don't have to deal with the
minimum floor. It's only during times of "crisis" that that
aspect of the cash flow is faced.
CHAIR GIESSEL thanked Mr. Galvin for his presentation and
invited Mr. Johnson to testify.
11:06:42 AM
MR. J. BENJAMIN JOHNSON, President and CEO, BlueCrest Energy,
Fort Worth, Texas, said BlueCrest is operating only in Cook
Inlet right now and he would only speak to issues particular to
the Inlet. First, he emphasized that the tax credit program is a
very good investment for the state, with a good return which he
would illustrate. He said BlueCrest has not been involved in any
wildcat exploratory drilling. Instead, they have focused on the
low-risk development of previously identified resources of oil
and gas in the Cosmopolitan Unit.
In the process of delineating the field in 2013, they discovered
several new oil and gas zones that added to the total reserves.
But the underlying basis of that project was the previously
known oil reservoirs. He said, "There really can be no question
that the state's investment in development of known reserves,
like we're doing at Cosmo, has a much lower risk factor than
support for higher risk exploratory drilling." It's important to
understand that the exploration work has to have been done in
order to get to this low risk development phase. So both are
important.
MR. JOHNSON said that BlueCrest's original development plan was
to find some oil and gas properties where reserves had already
been identified and where their particular expertise could be
used to make it more valuable. They looked all over the U.S. and
Alaska. They found that the cost for doing this work in Alaska
was roughly 300 percent more than in Lower 48 basins. What made
the difference in BlueCrest's decision to come to Alaska was the
state's incentive program: the tax credits and a zero oil
production tax rate in Cook Inlet until 2022. They chose to come
to Alaska and bought into the Cosmopolitan Unit.
11:10:36 AM
MR. JOHNSON emphasized that the state's investment in
Cosmopolitan will provide significant, future, positive value to
the state even at low prices. The state's tax credits have
facilitated the success they are bound to see on the
Cosmopolitan Unit. These credits will provide future positive
value. In fact, the tax credits under current laws can actually
provide higher rates of return to the state than the average
investments in the Permanent Fund.
11:11:18 AM
He explained that the Cosmopolitan's project is located three
miles offshore of Anchor Point in Cook Inlet; it is all on state
leases and subject to state royalty. They also have an onshore
lease that contains the production facilities and the drill
sites for drilling to the offshore leases.
MR. JOHNSON said in the interests of time he wouldn't go into
the lengthy Cosmopolitan history, but the field was originally
discovered in 1967. BlueCrest acquired its first leases in 2012.
In 2013 they drilled a critical well and gained new information
that has allowed them to finally begin developing the field
using current state-of-the-art technology.
The Cosmopolitan Unit consists of two separate development
projects. There are numerous gas wells directly above underlying
oil zones; these gas reservoirs are not connected to the oil
reservoirs. They haven't started developing the Cosmopolitan gas
zones yet; that development is on hold due to economic questions
concerning tax credits, the cost of drilling and confirmation of
a stable, long-term market demand. Two years ago, based on the
tax regime in the Cook Inlet, they committed to begin
development of the oil reserves and it is now under way.
MR. JOHNSON explained that BlueCrest is a small private company
with a singular focus on developing Cosmopolitan and they are
very careful in developing their business plans. This is a large
project for their company and they were also faced with the
challenge of paying for its development. Although the members of
the management team have a lot of experience, the cost was far
beyond their capabilities. So, they teamed up with a group of
oil industry investors who have much greater financial
capabilities and carefully developed their plan based on all of
the laws in place at the time.
11:14:31 AM
The point of slide 4 was to illustrate the cash flow of a
typical oil and gas project over time. It's important to see
that as the curve goes down, more money is being spent than is
coming in. However, when more money starts coming in, it's not
automatically profit. It simply goes to repaying the money that
was already invested. When that is done is when profit starts
being accounted for.
He noted that slide 4 was a representation of a successful
project where a company explores and actually finds something;
then it has to come up with the money to develop that
exploration success. One doesn't have exploration successes all
the time. In fact, the vast majority of exploration wells are
dry holes (two-thirds to 90 percent in the U.S.). However, that
work has to be done in order to get to the point of having a
success. And the profit from that success needs to pay for all
the unsuccessful exploration wells.
MR. JOHNSON said the good news about Cosmopolitan is that it is
literally a few days away from the very first commercial
production of oil after two years of hard work. In a couple of
months they will bring in a brand new drilling rig and begin
drilling new wells at a cost of about over $40-$45 million per
well and hopefully bring on the new production that will finally
allow BlueCrest to start paying off its loans. That new drilling
cannot start until the last half of this year.
Slide 5 showed BlueCrest facilities that are large enough to
process the oil from 20 new wells. They are also designed to
allow for future expansion. Final operation tests are being
conducted before starting production.
11:17:05 AM
He explained what the tax credits from a successful development
like Cosmopolitan actually mean to Alaska:
When the tax credits are used for development of new
proven reserves in the state, they are without
question, a good, valuable, low-risk investment.
Speaking of these credits as a give-away - as we hear
sometimes - just completely ignores the substantial
value that is received by the state. These tax
credits make new projects work, and they bring new
sources of long-term revenues to the state for decades
into the future. Now, Cosmo, we're sitting on a large,
proven, resource of future oil and gas that now simply
requires additional new investments to bring it to
full production.
11:17:57 AM
MR. JOHNSON stated that on February 19 the DOR provided its
analysis of the financial impact to the state on development of
a new typical Cook Inlet oil field very similar to Cosmopolitan,
assuming that no changes are ever made to the existing tax laws
(slide 7). Their example was actually more expensive and less
productive that what they think Cosmo will be. So, bottom line,
their calculations were conservative.
It shows the total benefit received by the state and
municipalities including taxes and royalties as a function of
future various oil prices. It shows that even for this
conservative example, the state would receive back 100 percent
of its investment in the tax credits if oil prices over the
entire field life average only about $35/barrel. At about
$47/barrel, the state would receive back double its investment
on the tax credits, and at about $59/barrel it would receive
back triple its investments made on those tax credits.
11:19:48 AM
The DOR also provided a discounted cash flow analysis for this
example that compared the impact of the tax credits as a pure
investment to the investments in the Permanent Fund (Permanent
Fund September 2015 earnings were 6.15 percent). The analysis
shows that if there are no any changes to the Cook Inlet tax
system the state's investment in those gets a better return than
the average investment in the Permanent Fund, as long as oil
prices over the next 30 years average only $44 barrel.
11:20:35 AM
MR. JOHNSON provided BlueCrest's specific comments with regard
to SB 130. First, termination or severe reduction of qualified
capital and well expenditure credits (slide 9) would result in a
significant reduction in their ability to continue making
investments in Cosmopolitan, resulting in less future revenues
to the state. The governor's original SB 130 bill completely
eliminated the well lease expenditure credits effective July 1,
but the House Resources and Finance Committees have suggested
reducing the credits by various amounts and phasing the
reduction in over a longer time period.
11:21:12 AM
The net operation loss (NOL) credit is valuable to a company in
the exploration or early development phase prior to reaching the
point of positive cash flow. But as a company like BlueCrest and
some others in the state continue expanding known resources, the
NOL credit becomes far less important; in fact it goes away.
BlueCrest does not expect to receive NOL credits in 2017.
What is important to allowing BlueCrest to continue drilling is
the well lease expenditure credit. Keeping the well lease
expenditure credit at 40 percent in Cook Inlet (as it is
currently) will result in a positive return to the state. But,
most importantly, it allows BlueCrest to drill at about $10
lower oil price than without the credit. That is likely to be
really important in 2017. If oil prices go to $100 a barrel,
they don't need the credits, but at $40 they probably would not
be drilling. The credits allow their operations to continue.
11:22:38 AM
BlueCrest's analysis of the value to the state of keeping both
the qualified capital credits and the well lease expenditure
credits is that it gives them the ability to function at a
$10/barrel lower price and return 100 percent to the state in
both royalties and future taxes. The state would be fully repaid
at $24/barrel on each new well drilled. At $40/barrel the return
is 200 percent, and at $60/barrel the return is about 250
percent. So, these credits, at least for Cosmopolitan, are
expected to provide a very good return and be a very low risk
investment for the state.
Another factor in SB 130 limits the amount of credits that can
be paid annually. But Mr. Johnson said, the governor's $25
million minimum does not take into account the differences in
qualified investments made by different parties in the state. If
the limit is too low, it's really particularly damaging to small
companies like BlueCrest that has invested its money in good
faith based on tax policies in effect at the time. So, the
timing of the payments is critical.
MR. JOHNSON said the most important factor is the timing of
implementation of the changes. Here it is April and the proposed
changes in SB 130 are supposed to take place on July 1, 2016.
The House helped solved that issued by moving the date back. He
explained that before BlueCrest started its development program
two years ago, they made sure they would have enough funds to
allow them to complete the construction of everything they are
developing: the drill site, production facilities, and bringing
in the most powerful drilling rig in Alaska to drill at least
the first two wells whose production will pay the debt service
on their loan. The changes have to start post July 1, 2016.
He explained that for BlueCrest, it cost $525 million to get to
the point of not having to borrow any more money (slide 12).
They put in $200 million of their own money and borrowed $30
million from the Alaska Industrial Development and Export
Authority (AIDEA) on a rig loan. The total they have received to
date in tax credits is $24 million. Based upon their budgeting
going forward they will receive $121 million additional tax
credits. So, that leaves them short by about $150 million; so,
they went out and negotiated a high rate development loan for
$150 million. That is how they have funded Cosmopolitan. The
bottom line is if the credits change, they are not paid, or if
they are not paid on time, there will be problems in making
their debt service and reaching the point of self-sufficiency.
Lastly, he reemphasized the importance of phasing changes in
over time. The most dangerous thing one can do on icy roads is
suddenly slam on the brakes; they don't want to see that happen
here.
11:27:28 AM
SENATOR STEDMAN said he personally doesn't figure property
taxes, royalties, and income tax in looking at the state's
credits. The production tax had been historically "siloed" to
benefit both the industry and the state through credit programs.
They should just have the zero severance and be done with it and
only look at credits against royalties. If they decide to go
down that road, the state should talk about taking an equity
interest instead of providing credits.
He didn't think the comparison with the Permanent Fund was at
all relevant. The Permanent Fund and the way its assets are
allocated, its purpose, and why it has its charter return ranges
is a whole different animal than the oil industry. The
discussion should concentrate on the benefits of the credits to
the state and the industry, and if they have to be modified
because of cash flow issues, how that is done without "turning
the apple cart upside down" either through lower funding on
appropriations, interest carried costs, or timing of when
changes are made.
He thought it was more on point for BlueCrest to look at how any
changes to the credits might impact them within the corporate
structure and how the state and industry can get out of this
pickle, because they can't stay on the course they are on.
SENATOR STEDMAN asked how much flexibility there is before the
apple cart gets turned upside down if they change the timing of
paying the credits.
MR. JOHNSON answered that BlueCrest has not borrowed any money
based upon the tax credits, yet. They have been negotiating with
banks on that for some time. In their basic assumption they
borrowed the money at a high interest rate for the full
development. If they can borrow money at a lower interest rate,
after they have spent it but before the tax credits come in,
that saves them some time. All the loan does is save them the
time value of money in terms of the interest being saved. All of
their plans were based on borrowing money.
11:32:11 AM
SENATOR STEDMAN asked him to clarify if he was saying that if
there was a delay in payment of the credit because the
legislature didn't appropriate the funds that it might take two
years for BlueCrest to get its credit. He wanted a finer point
on a company-specific, risk level to that policy change of fully
funding the credits versus some funding mechanism below that
that starts the whole carry forward process, and first in/first
out payout.
MR. JOHNSON responded that in their case the timing of the
credits is absolutely "imperative," - probably more so than for
somebody who is borrowing money from a bank for just the tax
credits themselves. If the state takes two or three years to pay
these credits the delay is very expensive for BlueCrest, because
at a 20 percent interest rate the credit is worth half of what
it was originally worth.
SENATOR WIELECHOWSKI asked if Mr. Johnson would be open to a
system where the state would get an equity position in
production for the tax credits. So, if the state provided a 40
percent tax credit it would get a 40 percent stake in the value
of the production.
MR. JOHNSON responded that the state already has a one-eighth
ownership with no cost basis in terms of the royalty. The North
Slope has some higher rates, but it's 12.5 percent in Cook
Inlet. An equity interest is entirely different, because with
equity one assumes all the risk of everything. The credits were
set up for each individual expenditure. The 40 percent credit
for a new well expenditure was set up to encourage drilling and
clearly the state gets a good return on that investment. From
that standpoint, equity is very different from tax credits or
from royalty.
CHAIR GIESSEL thanked Mr. Johnson.
| Document Name | Date/Time | Subjects |
|---|---|---|
| SB130-Caelus Testimony to SRES-4-9-2016.pdf |
SRES 4/9/2016 9:00:00 AM |
SB 130 |
| SB130- Presentation to SRES-Furie Alaska-4-9-2016.pdf |
SRES 4/9/2016 9:00:00 AM |
SB 130 |
| SB130-Presentation to SRES-Ahtna-4-9-2016.pdf |
SRES 4/9/2016 9:00:00 AM |
SB 130 |
| SB130-Great Bear Testimony to SRES-4-9-2016.pdf |
SRES 4/9/2016 9:00:00 AM |
SB 130 |
| SB130-BlueCrest Testimony to SRES-4-9-2016.pdf |
SRES 4/9/2016 9:00:00 AM |
SB 130 |