Legislature(1995 - 1996)

03/17/1995 03:55 PM RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
 SRES 3/17/95                                                                  
              SB 114 HIGH COST MARGINAL OIL WELLS                             
  CHAIRMAN LEMAN  called the Senate Resources Committee meeting to             
 order at 3:55 p.m. and announced SB 114 to be up for consideration.           
 CHUCK LOGSDON, Chief, Department of Revenue Petroleum Economist,              
 briefed the committee on high cost marginal wells and Alaska's                
 severance tax.                                                                
 The severance tax is levied on all barrels of oil produced in the             
 State of Alaska.  The tax is calculated on a field by field basis             
 by multiplying the number of barrels of non-royalty oil by the                
 wellhead price multiplied by the tax rate (either 15% or 12.25%               
 depending on the age of the field) by the economic limit factor               
 The ELF is specifically designed to recognize the productivity of             
 each field that is severance taxed.  It has a value that ranges               
 between zero and almost one.  It can never be one.  This means that           
 you take the value of production times the tax rate which results             
 in a percentage reduction in that total calculation based on how              
 productive the field is.  For instance, if the ELF was 0, 0 times             
 0 is 0, and you wouldn't pay any severance tax at all.                        
 SENATOR FRANK asked how wellhead is calculated.  DR. LOGSDON                  
 clarified that just transportation costs to the point of sale are             
 deducted.  He said that the appropriate wellhead value is something           
 that the state and oil companies have fought about ever since                 
 Prudhoe Bay came on line.  There is no field cost allowance on the            
 severance tax side, but there is on the royalty side.  There is an            
 allowance for gathering and dehydrating for most of the fields.               
 DR. LOGSDON illustrated the formula before the committee for                  
 clearer understanding.  He said you could also characterize the ELF           
 as a percentage reduction in the total tax as calculated by                   
 wellhead and rate.  You could also think of it as a percentage                
 reduction in the number of barrels that pay the maximum rate.                 
 The ELF does provide considerable tax relief to the marginal wells            
 and small oil fields.                                                         
 He explained that the ELF reduces the severance tax rate as both              
 per well and overall field wide production declines.  The bigger              
 the field and the better the wells, the higher the tax.  The first            
 300 barrels produced out of every well are tax free.  The way it's            
 designed there are tax benefits to small oil fields.  Most fields           
 (not barrels) in Alaska pay $0 severance tax.                                 
 At this point Dr. Logsdon explained some graphs he handed to the              
 committee titled: "Alaska Severance Tax Summary Table," "Economic             
 Limit Factor," "Field Size and ELF," and "Shrinking Piece of                  
 Shrinking Pie."                                                               
 On the ELF formula, itself, he said it was easier to understand if            
 you break it into two parts: ELF = (1 - 300/WP) - WP is the average           
 production per well in an oil field.  He explained the reason the             
 first 300 barrels are tax free is because if the average well                 
 produces 300 barrels a day and you substitute 300 and you get 300             
 over 300 which is 1 and 1 - 1 is 0 and 0 times 0 is 0.  So if the             
 field averaged only 300 barrels a day per well, there would be a $0           
 ELF and there would be no severance tax.                                      
 The second part of the formula is ^(150,00/TP)^1.5333) or the field           
 size adjustment.  TP is the total daily production from the field.            
 As field size decreases, it pushes the ELF down for a thousand                
 barrels per well per day.   As the field size increases the field             
 size factor makes the ELF go up.                                              
 DR. LOGSDON said that only about five of the roughly 21 producing             
 Alaska fields pay any oil severance tax.  The tax rate is now                 
 falling. If you were to apply the same ELF that was applied in 1990           
 to 1994 production, the industry would have paid an additional $9.4           
 million in taxes.  That is the tax benefit measured if the ELF                
 would have been frozen in at the 1990 rate.                                   
 Number 348                                                                    
 DR. LOGSDON said for the future, because the production tax rate              
 will fall as production falls, at some point in time every aspect             
 of the formula will fall.  On the severance tax side, a few years             
 in the future we will be getting a shrinking piece of a shrinking             
 Number 394                                                                    
 SENATOR FRANK asked what the picture looked like on royalty.  DR.             
 LOGSDON answered that there isn't an ELF concept on the royalty               
 side.  Every field pays what the lease terms were.  On the field              
 cost issue, he said, that allowance is a fixed amount that's                  
 adjusted for inflation.                                                       
 Number 437                                                                    
 SENATOR FRANK commented that royalty, then, would be a constant               
 piece of a shrinking pie.  DR. LOGSDON agreed.                                
 SENATOR FRANK noted that there is the corporate oil and gas tax and           
 asked if that apportioned world wide profits.  DR. LOGSDON answered           
 that it did.  He said it's difficult to say if that tax would                 
 shrink with the pie, so to speak, because it depends on how much              
 off setting activity there is.                                                
 DAVID JOHNSTON, Chairman, Alaska Oil and Gas Conservation                     
 Commission, said this bill would encourage continued production of            
 the high cost marginal wells.  It would probably also return some             
 currently shut down wells to production.  It might make Alaska a              
 more competitive place to do business.                                        
 To put it in perspective, he said, this bill would make the price             
 of oil for marginal wells $19 per barrel instead of the going rate            
 of $17.  In the Cook Inlet Region, basically 41 wells would                   
 qualify.  Total production out of those wells is a shade under                
 700,000 barrels.  A two dollars per barrel credit would cost the              
 state $1.4 million.  He said it was harder to estimate how many               
 wells would be returned to production under this legislation,                 
 although he thought there would be some additional production.                
 There are a few wells on the North Slope that would derive some               
 benefit, but in 1994 only six wells would qualify, MR. JOHNSTON               
 said.  Historically, 28 wells would have qualified in 1990, 33                
 wells in 1991, 28 in 1992, 32 in 1993.  Production numbers range              
 anywhere from just under 400,000 in 1990 up to 630,000 in 1991, and           
 560,000 in 1992.                                                              
 MR. JOHNSTON said that SB 114 is a modest proposal not costing the            
 state much money - about $5 million per year in credits.  It would            
 keep some wells in production that would continue to pay a royalty.           
 This bill will better ensure the royalties will continue to be                
 realized by the state.                                                        
 Number 516                                                                    
 He suggested deleting language on page 2, line 22 and just go with            
 the $1,000,000 per well or the $5,000,000 per producer.  Otherwise            
 the language would essentially do nothing.                                    
 SENATOR LEMAN asked if his fiscal analysis of SB 114 was based on             
 the assumption that that particular section is deleted.  MR.                  
 JOHNSTON answered yes.                                                        
 Number 555                                                                    
 SENATOR FRANK asked if these wells pay a severance tax.  MR.                  
 JOHNSTON said they didn't.  SENATOR FRANK asked if it was just                
 reducing a royalty payment.  MR. JOHNSTONE said he understood it to           
 mean that it would keep these wells producing and we would be                 
 getting 12.50% royalties on that production.  On a 100 barrel well            
 that would net approximately $125 back to the state, but it would             
 cost us $200 in credits.  You could offset that with some royalties           
 that would possibly be lost in the absence of these credits.                  
 MR. JOHNSTON said that SB 114 is just one approach to encourage               
 production.  He thought reducing the royalty would be like bringing           
 a sledge hammer to bear against the problem.                                  
 Number 571                                                                    
 SENATOR LEMAN asked him to explain the transferable tax credits on            
 page 3, line 2.  MR. JOHNSTON explained that you may receive                  
 credits, but not have any severance tax to apply it to in which               
 case the credit could be sold to another producer who does have a             
 tax obligation, or wants to purchase leases, or has a field he                
 wants to develop that would have a higher ELF.                                
 TAPE 95-23, SIDE B                                                            
 SENATOR LEMAN asked if it would be possible for the legislature to            
 require that there be benefit to the state in a transaction like              
 that.  MR. JOHNSTON said that wouldn't necessarily be anything the            
 state would be concerned with, that it's just a commodity for                 
 producers to sell or purchase.                                                
 SENATOR FRANK said it seemed like we are subsidizing production and           
 he was more interested in subsidizing exploration activities so we            
 could increase profitable production.  He didn't really support               
 taking money out of the treasury to keep a well in production if              
 that's what is being proposed.  MR. JOHNSTON agreed that                      
 exploration should be encouraged, but this is just a tool to ensure           
 that the production we do have, especially in the Cook Inlet,                 
 remains on stream.  He thought this would be economically                     
 significant to the people who live on the Kenai Peninsula.                    
 SENATOR HOFFMAN said, looking at the fiscal note, it looks like it            
 would cost the state $1.1 million through 2001 and asked what the             
 benefits would be in terms of jobs and the total annual salary that           
 would be gained by keeping up the production of these fields as a             
 result of the legislation.  MR. JOHNSTON said he didn't have that             
 information.  He thought the operators in Cook Inlet would have a             
 good idea.                                                                    
 Number 494                                                                    
 BRAD PENN, Marathon Oil, explained that the credits are not a                 
 payment out of the treasury; it's just a reduction of what would be           
 coming in if these wells are kept in production.                              
 SENATOR LEMAN said that possibly the credits should be limited to             
 those similar type projects.  MR. PENN said, theoretically, you               
 might be able to assign a credit to someone who wants to bid on               
 leases and drill an exploratory well with up front royalties.                 
 DEBORAH VOGT, Department of Revenue, pointed out that the fiscal              
 note needed revision if subsection (a) of b (2) was deleted.                  

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