Legislature(1997 - 1998)

02/20/1998 03:40 PM RES

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
         SB 256 - REDUCE ROYALTY ON COOK INLET OIL & GAS                       
CHAIRMAN HALFORD announced SB 256 to be up for consideration.                  
Number 440                                                                     
SENATOR PEARCE, sponsor, said it offers a royalty holiday specific             
to Cook Inlet to help make sure that the oil and gas industry                  
remains strong and is a response to concerns put forward by our                
largest gas distributer, Instar, about long term supplies of gas.              
Her bill doesn't deal with exploration; it deals with production of            
fields that have already been discovered, but haven't been brought             
on line for various reasons.                                                   
The Kenai Field, the area's largest and oldest producing gas field,            
is more than 88 percent depleted.  This could lead to gas shortages            
which would lead to rapid price increases for residential and                  
commercial consumers.  This would threaten the viability of                    
Unocal's fertilizer plant and the Phillips/Marathon LNG export                 
facilities at Nikiski, both of which provide substantial employment            
opportunities and vital revenues for South central Alaska                      
communities.  She also stated that the bill applies to oil as well             
as gas.                                                                        
Oil and gas produced from undeveloped or shut-in fields brought                
into production before January 1, 2004 would pay a reduced royalty             
of five percent instead of the 12 + specified in the lease for a               
period of 10 years following the date on which production began.               
SB 256 isn't intended as a one way street.  In order to qualify for            
a reduced royalty, the lessees have to act immediately to delineate            
the fields and bring them into production by 2003 - a fairly fast              
track in the oil and gas industry.  A preliminary review shows                 
eligible fields will include Falls Creek (gas), Nicolai Creek                  
(gas), North Fork (gas), Redoubt Shoal (oil), Starichkof (oil), and            
West Forelands (gas).  The goals of the bill are simple - to                   
develop new sources of natural gas and oil to offset declining                 
production in the Inlet.  This will mean more jobs for Anchorage               
and Kenai Peninsula area residents.  Having production in the near             
future rather than the far out future will help keep productions at            
a level that will insure that the industry stays on track and will             
continue to support the commercial entities that have built up                 
around the industry.                                                           
In the fiscal note, the Department says that they can't estimate               
the numbers, but they have an analysis.  One of the points they                
have is  why can't these fields just apply for a royalty reduction             
under HB 207. She said it wasn't their intent, but they may have               
built HB 207 in a way that it didn't really work.  It set out an               
opportunity for closed door negotiations between any administration            
and any company and could have led to decisions on whatever                    
happened to be politically correct or in vogue at the time.                    
SB 256 leads to no closed door negotiations.  It's very clear.  If             
you are eligible under some very specific rules, you get a straight            
royalty holiday of a certain amount for a certain period of time.              
She noted that there was no relief for the Badami Field.  One of               
the problems with HB 207 is that until you can drill more                      
delineation wells, you can't give the Department enough information            
to give you the HB 207 relief.                                                 
SENATOR PEARCE noted that the top of page 2 in the letter from Mr.             
Boyd, the Department brings up a particular point about a Redoubt              
Unit agreement with Forcenergy.  The Department says that at no                
time during negotiations with Forcenergy was the issue of royalty              
reduction raised.  She understands that Forcenergy did raise the               
question with Patrick Coughlin of the Division of Oil and Gas and              
there is record of that.                                                       
Number 530                                                                     
SENATOR SHARP commented isn't it true that five percent of                     
something is better than 0 percent of nothing.                                 
SENATOR PEARCE responded that this is a case where we know there               
are fields, they haven't been brought on line, and they are small.             
If some people are uncomfortable in not seeing an upside, you could            
cap the size and number of barrels you want to give a royalty                  
holiday to.  She said we are not betting on exploration; we are                
talking about accumulations we know about, but aren't economic at              
CHAIRMAN HALFORD said sometimes production has more to do with what            
the market can absorb at that time than it does with the economic              
viability of a particular source of whatever that product is.  He              
asked if that was a factor.                                                    
SENATOR PEARCE answered that there was no real way to know that.               
Waiting for the market is great, but in this particular case, we're            
waiting for the market and while we wait, we may see South central             
energy prices go up dramatically.  She wanted to act before that               
happens.  She didn't know if there was an answer to his question               
and noted that the answer might be different for gas and oil.                  
SENATOR TORGERSON asked if this royalty relief goes deeper than                
what is in HB 207.                                                             
SENATOR PEARCE said she didn't remember exactly.  It wasn't in the             
same terms.  There were three categories: exploration, already                 
producing fields, and shut-ins.  She is not sure if a field that               
was there, but had never been produced fit in anywhere.  SB 256 is             
more definitive.  She intends to ask the Department to figure the              
relief based on all six fields coming in.                                      
SENATOR TORGERSON asked what happened to Unocal's request.                     
MR. KEN BOYD, Director, Division of Oil and Gas, said he is not                
prepared to take a position on the bill.  It doesn't have a                    
provision to account for change in economic conditions and he                  
disagreed with her opinion on HB 207 with Unocal.  They worked hard            
and long with them and amicably, but HB 207 sets a pretty high                 
hurdle.  If Unocal gave up, they never told him.                               
He said it isn't clear to him which fields would qualify for the               
royalty reduction.  The six listed probably would.  Others could be            
included, but that might need further definition of what                       
undeveloped is.  In the recent announcement by Phillips at the                 
North Cook Inlet, it's arguable how a holiday reduction would work             
since there are shut-in wells in that field.  It might also apply              
to the Pioneer Unit (Unocal).                                                  
SENATOR TORGERSON asked if he had given any royalty relief under HB
MR. BOYD answered no and the only application they have received is            
from Unocal which sits in limbo at Unocal.                                     
TAPE 98-12, SIDE B                                                             
SENATOR TORGERSON asked if HB 207 was all smoke and mirrors for                
MR. BOYD replied that he had no comment on that.  The bill was                 
debated a long time in the legislature.  If you meet the                       
requirements of the bill, relief can be granted.                               
SENATOR TORGERSON said he would like to call Unocal and get the                
other side of the story.                                                       
MR. BOYD responded that he was sitting right across from someone at            
Unocal now.                                                                    
SENATOR PEARCE clarified that the six fields she is talking about              
came from Mr. Richard Kornbrath, DNR, who did an analysis of                   
historical oil and gas lease sale and exploration data for Alaska              
in 1995.  They are the six fields the Department, itself, called               
undeveloped.  There are other abbreviations including producing,               
abandoned, shut-in, and discovered prior to competitive leasing.               
She took the undeveloped list and the ones that fit into the time-             
MR. BOYD responded that the words in that pamphlet are not a matter            
of law; it's a matter of common usage.  It's merely descriptive                
SENATOR PEARCE said she didn't mind putting definitions in the                 
CHAIRMAN HALFORD asked Mr. Boyd to carry the fiscal note out to                
some other conclusion than the example of one project.                         
MR. GARY CARLSON, Vice President, Forcenergy, said they were new to            
Alaska about 15 months ago.  They came to look for opportunities to            
develop assets that might have been left behind by larger                      
companies.  They are very active and are a major lease holder in               
the State now.  They have made some acquisitions and committed $180            
million and are real investors in Alaska.  All that $180 million is            
in Cook Inlet.  They have 22 employees here; 18 were residents when            
they came to work for them; three of them had lived here before and            
one they recruited out-of-State.  They are going to grow their                 
company in Alaska.  They have made liberal use of local contractors            
and consultants.  He supported SB 256 saying he has seen these                 
types of incentives work well in other places in the world.  It                
attracts capital investment in a timely fashion.  He thought we                
have less than five years to make investments to take advantage of             
an opportunity to develop fields that might have been left behind              
by the majors.  There will be activity soon, at least for them, if             
this bill goes through.  SB 256 will clarify the gas supply                    
concerns.  Any additional infrastructure that is developed as a                
result of trying to develop these shut-in fields will support other            
Number 498                                                                     
SENATOR TORGERSON asked if he would oppose some identification of              
how big a field could go up to before the royalty relief would end.            
MR. CARLSON answered setting a cap on the volume of barrels or                 
billion cubic feet (bcf) of gas would still fit the spirit of the              
bill.  Redoubt Shoal, for instance, would take a certain number of             
barrels to make an attractive return - even with the royalty                   
holiday.  If the volume was selected thoughtfully, it would work               
and the State would benefit, if it is a huge field.                            
SENATOR TORGERSON asked what the volume would be or was he                     
suggesting a by well figure.                                                   
MR. CARLSON answered from a planning standpoint the total volume               
would probably be a good cap.  At current prices that would be                 
between 40 million and 50 million barrels, even the royalty, to                
have an attractive investment.  He was sure they could come to a               
comparable volume of bcf of gas.                                               
CHAIRMAN HALFORD said it seems the capacity for State support of a             
field has peaked; and on the trailing end, Forcenergy would get the            
royalty relief to avoid shutting it in later.                                  
MR. CARLSON said obviously you would want to keep the fields on as             
long as possible.                                                              
CHAIRMAN HALFORD asked if there were any other costs to them and               
income to the State, other than royalty, that is more profit                   
sensitive.  Royalty is essentially a gross fee on amount.                      
MR. CARLSON said he would have to think about that a little bit,               
but when you look at the burdens you put on a project, royalty                 
comes off the top.  As a matter of course, he's encouraged                     
Forcenergy to make an up-front investment to buy out overriding                
royalties, because the ongoing burden is what takes you out of                 
business when the oil prices are tough.  Another area that would               
apply similar to that would be any burdens they would have in                  
moving oil around, like tariffs, which is an issue in Cook Inlet               
where they pay a couple dollars per barrel just to move it from one            
part of the pipeline system to another, then put it on a boat to               
move it across the Inlet, which is another dollar.                             
CHAIRMAN HALFORD said he was surprised he didn't mention income                
MR. CARLSON responded that they hadn't reached that point, yet.                
Number 400                                                                     
MR. KEVIN TABLER, Unocal, supported legislation which he said                  
creates incentives for the exploration and development of the                  
State's natural resources.  Cook Inlet is Unocal's primary area of             
focus and they are encouraged that responsible incentives are being            
discussed which will increase activity and possibly increase the               
development of several known shut-in fields, some of which were                
discovered over 30 years ago.  Today's declining Cook Inlet reserve            
base has created a need for discovery of new reserves and the                  
development of known accumulations.  This will require expansion               
and utilization of the existing infrastructure in taking advantage             
of economies of scale.  The time is right to access the existing               
accumulations, but access alone will not make these reserves                   
economically viable.  The Cook Inlet, with its mature and declining            
fields low margin property, high operating costs and regulatory                
uncertainty, creates a challenging environment in which to stay                
profitable.  Unocal's investments are continually threatened by                
global competition for investment dollars.                                     
Product price plays a key role in field development, but in                    
undeveloped or shut-in fields which are marginally economic,                   
product prices and other uncontrollable conditions limit                       
development opportunities unless adequately offset by some other               
A clear, certain and easily administered way to reduce start-up                
costs of undeveloped fields and improve their overall economic                 
viability is to reduce the royalty burden.  This factor, alone, is             
controllable, creates certainty, and reduces risk.                             
SENATOR TORGERSON asked him to update their application for HB 207.            
MR. TABLER answered that although he was not directly involved in              
the negotiation of it, he is familiar with what took place.  They              
concluded that the amount of relief they would have qualified for              
was not worth the time and effort they had spent to date.  In fact,            
it wouldn't even pay for the cost of going through the technical               
analysis that was required.  He said they hadn't pulled their                  
application, but they just haven't pursued it.  He said that                   
language in HB 207 for marginal fields was subjective and requires             
negotiation and the determination of what is in the State's best               
interest.  Prior to HB 207, the Commissioner only had the authority            
to adjust royalties; HB 207 sought to provide further adjustment               
for economic relief.  It's a difficult position for the                        
Commissioner to be in, because he has a mandate to protect the                 
State's interest.  This is in direct conflict at times with the                
analysis that the company goes through in making an investment                 
decision.  They concluded that as  long as there was a positive net            
present value on any of the projects they proposed, the State was              
not inclined to grant royalty relief.  There are very few companies            
engaged in fully designing and analyzing money losing ventures.  As            
a result, royalty relief is likely to be granted to those companies            
that have spent considerable resources on unattractive projects to             
show the clear and convincing evidence.                                        
MR. JOHN MIESSE, Marathon Oil, supported SB 256 and said in the                
long term it would have positive economic impact on the State of               
Alaska and local communities.  However, he thought it would have a             
more immediate impact on undeveloped or shut-in oil fields because             
of the readily available market for this product. The ultimate                 
incentive for adding reserve capacity is the availability of ready             
and stable markets.  Such a market is available for new oil                    
reserves in the Cook Inlet area, but the same cannot be said for               
natural gas.  New markets for uncommitted natural gas reserves are             
not available for the next several years making it difficult to                
economically justify near-term drilling expenditures.  Although                
this bill provides some economic benefit to the industry, it won't             
be enough by itself to stimulate significant activity for natural              
gas development in the near future.                                            
It's his understanding that the intent of this legislation is to               
provide the temporary relief to fields that have been undeveloped              
and shut-in and they would like to know their definition of                    
undeveloped.  Specifically, they would like to know if a field that            
has produced periodically over the last two years, but requires                
additional drilling to fully develop the field, would be eligible.             
Also, they would like to clarify whether royalty relief would apply            
to reentry of an existing well or a new well needed to recover                 
undeveloped reserves.                                                          
MR. MIESSE said that many of the oil and gas producing states                  
enacted similar incentives for oil and gas development in the early            
1990s.  These states have found the programs to be beneficial to               
all stake holders involved and have maintained those programs.                 
CHAIRMAN HALFORD thanked everyone for their comments and said they             
would bring this bill up again.  He adjourned the meeting at 5:00              

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