Legislature(2005 - 2006)CAPITOL 124
02/03/2005 05:00 PM House OIL & GAS
| Audio | Topic |
|---|---|
| Start | |
| Overview - Department of Revenue | |
| Overview - Department of Natural Resources | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
ALASKA STATE LEGISLATURE
HOUSE SPECIAL COMMITTEE ON OIL AND GAS
February 3, 2005
5:03 p.m.
MEMBERS PRESENT
Representative Vic Kohring, Chair
Representative Nancy Dahlstrom
Representative Ralph Samuels
Representative Berta Gardner
Representative Lesil McGuire
MEMBERS ABSENT
Representative Norman Rokeberg
Representative Beth Kerttula
OTHER LEGISLATORS PRESENT
Representative Jay Ramras
COMMITTEE CALENDAR
OVERVIEW: DEPARTMENT OF REVENUE
- HEARD
OVERVIEW: DEPARTMENT OF NATURAL RESOURCES
- HEARD
PREVIOUS COMMITTEE ACTION
No previous action to report
WITNESS REGISTER
DAN DICKINSON, Director
Tax Division
Department of Revenue
Juneau, Alaska
POSITION STATEMENT: Presented an overview of the Economic Limit
Factor
BILL VAN DYKE, Permitting/Unit Administrator
Division of Oil and Gas
Department of Natural Resources
Juneau, Alaska
POSITION STATEMENT: Presented a briefing titled "Field
Development: What Drives Exploration and Development Decisions?"
ACTION NARRATIVE
CHAIR VIC KOHRING called the House Special Committee on Oil and
Gas meeting to order at 5:03:25 PM. Representatives Kohring,
Dahlstrom, Gardner, and Samuels were present at the call to
order. Representative McGuire arrived as the meeting was in
progress.
^OVERVIEW - DEPARTMENT OF REVENUE
5:04:54 PM
DAN DICKINSON, Director, Tax Division, Department of Revenue,
said that last year, the state's general fund (GF) brought in
$2.4 billion, of which $1.1 billion were from royalties, and
about $1 billion from taxes. Of the taxes, about $700 million
were from the production tax and the other $300 million were
from property taxes and income taxes. He noted that there are
about $300 million in state revenues that are not associated
with oil and gas. Focusing on the production tax, he explained
that it is calculated by multiplying four values: the wellhead
value of oil, the nonroyalty barrels, 15 percent, and the
Economic Limit Factor (ELF). He clarified that the ELF is a
number between zero and one; therefore if the ELF is zero the
whole calculation becomes zero, and if the ELF is one the
company pays the full 15 percent. He said that the ELF was
placed in the equation because [the state government] did not
want the production tax to be the incremental cost that shut a
well in. The effect has been that if a field has high costs the
ELF goes to zero; if a field is producing more barrels than are
needed to cover costs, the ELF is greater than zero and there is
a tax.
5:09:22 PM
MR. DICKINSON stated that the ELF is really a proxy for the
production that the company needed to cover its costs, including
transportation costs, tariffs, and the wellhead value. The
company is allowed to deduct all of those downstream costs but
not any of the costs at the production field, where investors
may have invested tens of billions of dollars. At the fields
the companies use the ELF to have the oil [production] tax free
if the production is below the ELF.
5:10:31 PM
MR. DICKINSON said:
It's only the production above the economic limit that
bears a tax, and the more barrels you have above the
economic limit, the higher the tax on you.... So the
notion of the ELF was, it was a proxy and it was going
to shield the volume of oil that was required to cover
the direct operating costs....
MR. DICKINSON mentioned that in 1989, a second exponent was
added to ELF to take into account field size so that a large
field like Prudhoe Bay, which was producing about 1.6 million
barrels a day (b/d), would bear a high tax, and a small field
would bear little or no tax. He stated that after this change,
the taxes on Prudhoe Bay and Kuparuk went up, and taxes on all
the other fields went down.
5:12:21 PM
MR. DICKINSON said that in 2005 there were only three fields
that were paying significant production tax: Prudhoe Bay, Alpine
and North Star each had ELFs of about 0.8. The next highest ELF
is Kuparuk with an ELF of about 0.1, which is considerably lower
than 0.8. He explained, "What can happen with exponentials is
small changes in the inputs make huge changes in the result."
MR. DICKINSON remarked that 2005 was the first year in which
about half of the [oil] production on the North Slope was below
the economic limit. "In other words," he said, "half the
production on the North Slope was needed to cover the cost on
the North Slope." He stated that according to the prediction
made by Department of Revenue (DOR), as much as 80 percent of
the oil on the North Slope will not have a production tax by the
year 2020.
MR. DICKINSON said that in the early 1990s the ELF for Prudhoe
Bay was close to one, but it has been slowly declining every
year since then as production falls. This same trend applies to
the ELFs for all the other North Slope oil fields, with a slight
raise predicted in 2010 when the Point Thompson field is planned
to come online. He said that every year there is less oil found
in Prudhoe Bay and more oil found elsewhere; therefore the
weighted average between the two leans more heavily towards the
"elsewhere" category.
5:17:39 PM
MR. DICKINSON explained the concept of Best Well Produces, which
is the production function that the [oil industry] uses to
maximize the amount of oil that can be put into the Trans-Alaska
Pipeline System (TAPS). He said, "[The oil companies] look at
all the wells that they have [that] could be producing, or that
are producing, and they try to find the one that's going to put
the most ... oil in the line." Production facilities, which are
needed to turn well fluid into quality oil, are presently
constrained by the amount of gas they have to handle. Eight
billion cubic feet per day (cfd) [of well fluid] goes into the
central compression plant, he noted, "and the ability to handle
that ... is what is the real constraint on the ability to
produce gas on the North Slope." He said that the [oil
industry] wants to shut in a well that is producing a lot of gas
and not much oil, and bring on a fresh new well that will
produce a lot of oil and not much gas.
5:20:01 PM
MR. DICKINSON pointed out that the amount of gas increases over
time for any well and said:
When you start out you're getting a lot of oil, you
take the gas off, you reinject it, you put it back in
... and what happens is you find the gas/oil ratios
[GOR] go up, and they go up phenomenally. ... In
general the wells that they're finding they want to
shut in are the wells in Prudhoe Bay. ... Under the
tax system [DOR decided that] if a well or a field or
an entity is producing a lot of oil and it's strong,
if it has a lot of production above the economic
limit, then it has to pay a lot of tax. A robust
field should be able to bear some tax. And those are
the wells that [the oil companies] are saying, ...
"These robust wells are the wells that we actually
want to shut in." Then you go out to a satellite.
These satellites are relatively fresh; they've been
discovered in the last couple of years and by fresh I
guess I just mean they have a low [GOR]. Now
according to our tax system these wells might have a
zero ELF or a very low ELF. Our tax system said
[that] these wells are somehow disadvantaged... [and]
need help from our tax system or otherwise they won't
produce. That was the theory behind the ELF. And
[the oil companies] are saying, ... "Let's take a well
that apparently under our tax system needs support -
we're going to call it the Best Well and we're going
to bring it on line and we're going to shut down one
of these supposedly robust wells in the middle of
Prudhoe Bay." And fundamentally that ... doesn't seem
to be what was intended by the ELF.
5:21:38 PM
MR. DICKINSON summarized:
[The oil companies] are already treating all the wells
that feed into the common production facilities at
Prudhoe Bay, the satellites and the initial
participating area, all those wells are being treated
to a common production function and they are saying,
"Some wells we don't think ought to be producing", but
those are the wells that according to our tax system
are the Best Wells, the wells that can afford the
highest tax. And they're saying the wells they want
to bring on are the wells that our tax system was
saying needed encouragement. And that's why looking
at it you say, "There's been a mismatch between the
tax system and the way it's operated."
5:22:25 PM
MR. DICKINSON turned attention to the idea of giving incentives
to the oil industry [in order to encourage them to explore and
develop in Alaska]. He remarked that the state needs to have
effective incentives that produce the desired results. He said,
"It was [DORs} analysis looking at this that in fact that was
not what was going on in Prudhoe Bay."
MR. DICKINSON described ELF as an imperfect proxy. He said that
though it would have been more pertinent before the 1989 ELF
changes, this notion is still useful. To apply this idea, a
company would take the proxy for its costs, build it into a
volumetric function, and then decide how good a proxy it is. He
presented a simplified example of the use of ELF as a proxy: if
a company is producing 600 barrels per day (b/d) that can be
sold for $10 per barrel, the total revenue would equal $6,000.
If the actual costs were $3,000 then the profit would equal
$3,000. If the price doubled to $20 per barrel, then the
company would be making $12,000, but most of the costs
associated with producing a well are not tied to energy costs,
he explained. Therefore while the actual costs stay at $3,000,
the profits actually triple to $9,000.
5:25:53 PM
MR. DICKINSON reiterated that when ELF is used as a proxy for
costs, 50 percent of production, or 300 barrels, will cover
costs while 300 barrels will be given back to the shareholder or
will be used for further investment. In that case, he said that
the company will get $6,000 tax-free because it can sell 300
barrels to cover its cost. In summary, he said that as prices
go up, the company is allowed a larger proxy cost for its actual
cost even though the actual cost stays roughly the same. When
prices halve the ELF drops lower and the company wouldn't be
able to completely cover actual costs. However the barrels that
the company could sell for its costs would cover $1,500 worth of
costs, or half of its costs, and the barrels that are sold for
profit would also drop to $1,500. He remarked that this is a
much smaller effect, and that "when you're halving things you're
going to end with a smaller effect than when you're doubling
them."
MR. DICKINSON stated, "The statutes say that the DOR has the
authority to aggregate or, if it's appropriate, to segregate,
but basically to redefine ... the boundaries of what we'll use
for calculating the ELF. In other words, we're supposed to find
a ... production set ... that has an identifiable economic limit
factor...." He referred to the statute AS 43.55.013(j) and
said, "[The statute] specifically says that we can aggregate
certain leases, properties, or portions of them." He explained
that, effective February 1, 2005, [the administration] combined
six satellite fields with the Prudhoe Bay initial participating
area (IPA) for production tax purposes.
5:29:04 PM
MR. DICKINSON said there were three reasons why the department
decided to exercise its discretion and ask the producers to
aggregate. He said, "The first [reason] was essentially an
argument which I'll just call Substance Over Form. We believe
... that the field is being operated as a single unit. If what
you're driving at with the ELF is to try to isolate costs, ...
if in fact the field has a single set of costs, then you ought
to recognize that; it ought to be treated as a single unit for
purposes of ELF. ... We believe that brought it more in line
with the intent of the original legislative intent."
5:30:01 PM
MR. DICKINSON said that the second reason for the [Prudhoe Bay
aggregation] change is due to measurement concerns. He
explained that satellite fields that share production facilities
do not have meters on the individual pipelines; the oil is only
metered when leaving the facility. Therefore the companies must
estimate the volume of oil coming from each individual area, and
he stated, "If you can't figure out how much is coming from each
then you ought to simply treat them as one."
5:33:56 PM
MR. DICKINSON explained that the third reason for the ELF change
is the persistent high oil price. He said:
If you think back to the purpose of trying to say that
production below the economic limit was tax-free and
production above the economic limit should bear some
tax, and in the ELF as it's now [constituted]...,
there was no way to plug price in there.... It was
just simply a proxy.
MR. DICKINSON referred to a graph on slide 11 of a handout
titled, "Economic Limit Factor, AS 43.55" which demonstrates
that oil prices have been higher than usual recently. He said
that economists believe that "since 1999 we have been in a
different world than the world that came before that." The
average price since 1999 has been double the average price of
oil from 1986-1999. He opined that this is an era of high
prices and the standard for the economic limit ought to change.
MR. DICKINSON continued:
It ought to be reflective of the fact that the
economic limit, the amount of oil you need to produce
to cover your costs, is going to be lower when prices
are high.... One of the things we've observed ... is
that prices have been persistently high; they've
stayed high for five years. We don't think this is a
transient phenomenon.... As the [DOR] thought about
this application and what we ought to do, price played
a role and the persistent high prices were a part of
that.
5:36:28 PM
MR. DICKINSON referred to slide 8 of the handout, which was a
graph depicting volume of oil production over time. He
explained that Prudhoe Bay was an extraordinary field that was
substantially larger than the second largest field. He pointed
out that in the early years the Alaskan tax system was designed
and focused on Prudhoe Bay, but over time other fields have
played a larger and larger part in oil production on the North
Slope.
5:38:04 PM
MR. DICKINSON pointed out that the DOR has been tasked by the
governor to determine how Alaska compares with other countries
in competing for [oil industry investments]. He said that DOR
has collected nine studies that rate Alaska's competitiveness,
each completed within the past decade with different
methodologies. He briefly reviewed the studies, pointing out
that one study showed that Alaska was the least competitive area
of eight areas studied while another study determined that 85
percent of the areas studied were less competitive than Alaska
and 15 percent were more competitive. He said that generally,
Alaska is in the mid to high range; there are more places that
are uncompetitive compared to us than there are competitive
places.
5:40:22 PM
MR. DICKINSON directed attention to data released in the Wood
Mackenzie study titled "Global Oil and Gas Risks and Rewards
2004". He posited that the price of oil affected how the study
rated Alaska's competitiveness. He pointed out that Alaska was
the least competitive when the oil price was $13 per barrel, and
as the price went up, Alaska became more and more competitive.
For example, at $16 per barrel for oil, Alaska was 71 percent
competitive; at $22 per barrel, Alaska was 81 percent
competitive.
MR. DICKINSON explained that at high oil prices Alaska is one of
the best places to do business, and at low prices it is one of
the worst places to do business. He said that Alaska has a
regressive system: at low prices Alaska takes a very high
percentage and at high prices it takes a very low percentage.
He opined that this was a conscious aspect of the design to
ensure cash flow to the state regardless of oil price.
5:44:35 PM
CHAIR KOHRING asked why the oil companies aren't developing more
than they are since the oil prices are currently high. He
commented, "I'm not seeing a major upsurge in their investment
in the state here, so it suggests to me that maybe ... the
picture is not as rosy as it's being pointed out by these
studies and by your analysis."
MR. DICKINSON replied that perhaps projects are not being
evaluated at these high prices; they're being evaluated at
stress prices, a lower price, so companies are enjoying the
"windfall" but nobody is planning on this kind of price level
continuing. He said that [DOR] believes that there will be a
higher than normal price in the future. He admitted that he too
is mystified as to why there hasn't been more development
recently; he expected more investment at this point.
5:46:23 PM
CHAIR KOHRING raised the issue of costs associated with
developing a field before it actually comes online. He said
that when companies are exploring they aren't necessarily going
to find oil; they're going to have a few dry wells and so there
are potentially a lot of costs that have to be considered.
MR. DICKINSON agreed and stated his belief that two years ago
the governor and the legislature made the decision to pay for 40
percent of the costs of certain kinds of exploration, and 20
percent for other kinds. He stated that industry
representatives have suggested that the state cut back on
restrictions and make this incentive apply to any kind of
drilling or exploration. He opined that intervening at the
exploration end can have a more profound effect than intervening
as the ELF does, during the production end.
5:48:26 PM
REPRESENTATIVE GARDNER asked what the tax structure is in other
places and how it compares to Alaska's.
MR. DICKINSON said that tax structures can be categorized in
many ways. He gave the examples of regressive versus
progressive systems, and project deals where rates are set on a
project-by-project basis. He said that some areas tax profits
that are being expatriated; if the company is willing to invest
money in the country [it can keep all the money], but if the
company intends to take the money out of the country, the
country places a high tax on it. He opined that [tax
structures] are fairly fluid and changing.
5:52:11 PM
REPRESENTATIVE MCGUIRE remarked that when the ELF was conceived
the idea was to encourage companies to continue investing in
Alaska and to use the resources as efficiently as possible. She
asked if [DOR] has completed any analysis regarding what will
happen in future development.
MR. DICKINSON responded:
Every year ... there is [an] ... ever-increasing
amount of new oil in there so we have to be very
sensitive to the fact that we still believe that our
forecast has events that we think are going to occur
... and the future developments on the line will
occur. So yes, we are doing that analysis. ... It's
not a single dimension, it's not as if you can say ...
"High tax - no development, low tax - lots of
development." It's how you craft it, how you look at
it. We made a technical decision based on what were
the facts in front of us that we thought was the
appropriate way to tax this field.
5:54:36 PM
MR. DICKINSON mentioned that the president of ConocoPhillips
Alaska, Inc. sent a letter to the governor asking for [ELF]
rulings on the satellite fields at Alpine so that they can "do
their economics".
MR. DICKINSON stated that most of the oil companies are capital
constrained, but will invest capital where they think they'll
get the best return over time. He opined that the companies
will want to have a portfolio, and perhaps they will "invest
some in places that have a lot of upside and then some in other
places where they expect not to get a huge upside but ... where
the take will not be so great during the low prices."
5:56:08 PM
REPRESENTATIVE MCGUIRE stated that very often [the legislators]
don't understand the full implications of their policy
decisions. She noted that in 1989 a change was made to ELF to
encourage development of some marginal fields. She said, "Here
we are analyzing a very important, profound policy decision that
you've made on the administrative level that could have
implications that we won't see until 20 years from now." She
stated that she would have expected oil companies to have
invested more in Alaska in recent years with prices being high,
since at the high end companies make more money in Alaska. She
then asked if the [DOR] considered creating other incentives to
encourage more investments in Alaska.
5:58:11 PM
MR. DICKINSON stated that these are issues that DOR has been
trying to figure out for years. He reminded the committee that
the legislature passed an exploration incentive recently, plus
House Bill 61 which "put additional credits behind a development
in Cook Inlet". He said,
There are small things, ... we'll have to wait some
years to figure out how successful they were, but
there are things that can be done, [the legislature
has] done some, we've thought of them, they're
strictly within the sense of what we could propose to
the legislature. It's [DOR's] belief that the
investments that are [on the North Slope] are not
going to be negatively impacted as a consequence of
this. ... We believe, if folks are continuing to bring
on wells of this natural, they will continue to do
that, particularly at the current price regime. ... I
would not necessarily say that ... the folks who
designed the ELF in 1989 ... got what they expected.
... A lot of the focus was on stand-alone ...
production facilities. What has happened over time
is, when you share costs, when you can bring on
production and then take production facilities that
already exist on the North Slope and put that
production into them, that that's not what folks
contemplated.
6:01:20 PM
CHAIR KOHRING remarked that there are other major fields up on
the North Slope such as Kuparuk and Alpine, and they have
satellite fields around them too that are like smaller versions
of Prudhoe Bay. He expressed concern that perhaps [the
administration's decision to aggregate Prudhoe Bay with its
satellites] will set a precedent and be extended to the other
areas. He asked for further explanation as to why the
administration decided to make a change to the Prudhoe Bay
satellites.
MR. DICKINSON answered:
In our regulations there's a process set forth that
says a taxpayer who is concerned about the future
development can apply to us and get an advanced letter
ruling ... that says 'We will not aggregate this field
...,' essentially giving them some certainty about at
least that aspect of their production of the taxes.
MR. DICKINSON made the general observation that those letters
generally do apply to a great deal of production in fields such
as Milne Point and Kuparuk. He stated, "[DOR was] very careful
that when we took this step, ... we did not overturn ... deny
... any of the applications that we had ... taken and agreed to
not aggregate with."
6:03:27 PM
CHAIR KOHRING opined that a stable tax policy was important to
give the oil industry a chance to predict the future with some
certainty. He commented that he thinks other oil companies are
concerned about whether this change will be applied to their
fields and satellite fields as well.
MR. DICKINSON agreed with Chair Kohring, but argued that if
facts and situations change, a tax policy shouldn't be static or
frozen. He commented that he thought the people who wrote the
ELF gave the DOR certain discretion to [make changes if needed].
Having said that, he noted that having a consistent policy is
important.
6:05:18 PM
REPRESENTATIVE SAMUELS asked if the ruling not to aggregate
Kuparuk had been made recently.
MR. DICKINSON answered that when requests have been made under a
taxpayer confidential expectation, DNR has kept them
confidential. He stated, "A series of ... fields have been
added, so ... there have been a series of decisions; ... West
Sak and Tabasco are older, Tarn and Meltwater over the last
couple of years."
REPRESENTATIVE SAMUELS asked why Kuparuk was not aggregated
while Prudhoe Bay was aggregated.
MR. DICKINSON stated that Kuparuk's satellite wells are six to
ten miles apart, whereas Prudhoe Bay has numerous wells on the
same gravel pad, with each well going down to a different field.
He remarked that the producers might say that the wells are
still thousands of feet apart underground, but he said:
Nonetheless, if you're focusing on the superficial,
... what's on the surface, on the economics of putting
together the systems, I think you'll see that that's a
very different situation. ... In Kuparuk there is a
slight difference in ownership. It's not huge, but
there's a slight difference in ownership between the
satellites and the mother field. So anytime ... they
want to go use a production facility they've got to
deal with the fact that these are slightly different.
... One of the things that we saw happening in Prudhoe
is, up until 2000, the satellites were owned at very
different percentages than the mother field, and that
... impeded a lot of the development. One of the
reasons that the producers got together and created
what's called an equity redetermination and rearranged
everything so that everybody owned the same percentage
of everything, was to stop those kind of fights and
make sure that ... everyone was aligned.
6:08:40 PM
REPRESENTATIVE MCGUIRE asked, "Is it also possible that this
administration feared that ConocoPhillips and others had acted
in reliance on letters that you issued to make business
decisions?"
MR. DICKINSON stated that the DOR has never rescinded or altered
letters that it previously issued. He asked for clarification
of the question.
REPRESENTATIVE MCGUIRE remarked, "I just wondered if it was a
case of that company getting ... to you first ... and asking the
question in advance, where maybe BP and Exxon today kind of wish
they would've asked the question about Prudhoe Bay and gotten it
in writing as well."
MR. DICKINSON answered,
To go to your last hypothetical, they probably did but
I don't want to go to the first part and say that
therefore that first part follows. ... Clearly if you
read the regulation ... it was contemplated that these
would be issued beforehand, in other words, if it's
going to be a factor in the decision to invest then
you have the opportunity to get it before and to
insist on getting the letter before you make your
investment.
6:11:02 PM
MR. DICKINSON encouraged the committee members to examine the
table on slide 16 of the handout that included information such
as field name, daily production, number of oil wells, ELF,
production per well, and taxable daily production. Looking at
the slide, he pointed out that Kuparuk, which is producing about
155,000 b/d through 450 wells, has an ELF of about 0.17. He
compared this data to Alpine, which produces about 100,000 b/d,
and to Northstar, which produces about 65,000 b/d. He commented
that Alpine and Northstar, which have a total of 46 wells,
together produce about as much oil as Kuparuk, which has 450
wells. Because Alpine and Northstar are producing such high
volume of oil out of so few wells they have high ELFs.
6:13:40 PM
CHAIR KOHRING commented that he disagrees with the DOR, and said
that he hoped [the committee] can figure out a way to help the
industry with incentives. He remarked that there must be some
way "we can stabilize the whole situation and make them feel
like they're welcome here to do business; they're not going to
be subject to unstable tax policies."
^OVERVIEW - DEPARTMENT OF NATURAL RESOURCES
6:14:49 PM
BILL VAN DYKE, Permitting/Unit Administrator, Division of Oil
and Gas, Department of Natural Resources, referred to a handout
titled, "Field Development--What Drives Exploration and
Development Decisions?". He pointed out that slide 1 was a
geological slide depicting multiple oil pools, some shallow,
some deep, in a given area. He remarked that in Prudhoe Bay
there is one very large oil pool in addition to the smaller
ones. He explained that if there was only one small oil pool in
an area, perhaps no one would develop that area; but if there
were four pools it would be more likely that a company would
drill in that area. He said, "The smaller pools at the top,
they're more or less icing on the cake because, as in Prudhoe
Bay, the big oil pool supported the initial development. ... The
smaller pools ... can be supported by the previously installed
infrastructure."
MR. VAN DYKE explained that a company can access multiple oil
pools from a single drill site. He said, "Some of these real
high tech wells these days [can] reach out long distances and
access relatively small pockets of oil."
6:19:22 PM
CHAIR KOHRING asked if the technology exists to drill from
outside of the Arctic National Wildlife Refuge (ANWR) into the
area and not disturb the surface at all.
MR. VAN DYKE stated that there are some places where wells have
been drilled five miles horizontally, but such wells are very
expensive.
CHAIR KOHRING remarked, "That might dispel the whole argument as
far as the environmentalists are concerned, as far as
destruction of wildlife and potential spills if we just drilled
on this side of the border and just ran directional wells five
or ten miles into ANWR."
6:20:06 PM
MR. VAN DYKE stated that at the western end of the Prudhoe Bay
unit there are drill sites that access multiple oils pools. He
turned to the slide 3 of the handout to show a generalized
geological cross-section of the central North Slope. The fifth
slide was a map of the Prudhoe Bay field, which he said covers
about 248,000 acres and has over 100 individual oil and gas
leases in it. He remarked that the map shows that the main
Prudhoe Bay oil pool covers almost the whole unit. The
satellite pools are much smaller than the main pool and are
scattered around the unit area.
MR. VAN DYKE then turned to slide 6 of the handout which
depicted a map of the Prudhoe Bay unit surface facilities. He
commented that Prudhoe Bay is a small city, or industrial
complex. Slide 7 is another map of the Prudhoe Bay unit
depicting the shared facilities, which include gathering
centers, flow stations, power plants, and a gas-handling
complex.
6:25:06 PM
CHAIR KOHRING asked if there is a danger of losing gas in the
process of reinjecting it and if the gas will be easily
accessible in the future.
MR. VAN DYKE responded that the gas is reinjected back into the
Prudhoe Bay gas cap where there has been a gas accumulation
already in place for millions of years.
6:26:33 PM
MR. VAN DYKE pointed out that in 1977 there were multiple leases
[in Prudhoe Bay] owned by different companies or combinations of
companies. He reminded the committee that the large main oil
pool spreads underneath all of the leases, so all lessees own a
piece of the main pool and they each got their fair share of
production from their leases. However this approach didn't work
for development of the smaller satellite pools. He pointed out
that a company that discovered a small pool but didn't have
interest in the surface facilities was in a bind because the
companies that do own the surface facilities don't really have a
reason to help the small company.
MR. VAN DYKE explained:
People realized early on at Prudhoe Bay that there
were lots of these satellite pools. It's not that
they've just been discovered in the last five years;
people drilled through these satellites over the
years, since the discovery of Prudhoe Bay, literally.
And so they realized early on that there has to be a
better way to do business. And there were a lot of
negotiations over the year and finally in the year
2000 there was a successful conclusion to those
negotiations and it was a common equity agreement.
And what that means is that ... every company owns the
same interest in every lease. They figured out ...
what interest was fair for each company to own in each
lease instead of owning separate leases. And now the
companies don't care where the satellites are, they
don't care where the gas cap is for Prudhoe Bay, where
the oil rim is for Prudhoe Bay, they own the same
interest in everything and they also own the same
interest in the facilities on the surface. So now ...
it's fine for the best satellite to produce first
because everyone owns a common interest in everything.
And there are a few exceptions ... there are a few
facilities in Prudhoe Bay that the common equity
agreement does not cover, but they are ... in the
minority.... With this common equity agreement at
Prudhoe Bay ... the companies really have aggregated
their interests; they've taken all of their lease
interests and merged them into one big pot. Everybody
owns the same interest in everything. And it really
changed the way business is done at Prudhoe Bay; I
don't think it's any coincidence that, starting in the
year 2000 after this common equity agreement, that you
just see the satellite production blossom at Prudhoe
Bay, because before that there was a lot of commercial
negotiation that went back and forth ... really on
access to surface facilities. The people that owned
the satellite interests could drill them; they had the
right to drill their leases, they've always had that
right and they'll continue to have that right, but
they didn't have the right to use the ... surface
facilities. And now that is ... not an issue.
6:30:59 PM
MR. VAN DYKE remarked that the common equity agreement has
become "kind of the way to do business on the North Slope these
days," and now similar agreements have been made at other units.
He opined that the agreements really help business.
6:31:33 PM
MR. VAN DYKE turned attention to slide 10, which contained
information on ownership percentages.
MR. VAN DYKE, in response to a query from Representative
Gardner, explained that the PA on the slide stands for
"participating area", which is how the Department of Natural
Resources (DNR) describes the separate pools. He stated:
It is important from a lease standpoint which leases
are included in which pools because they may have
different royalty rates; they may have net profit
share provisions on some and not the other. Even
though the owners have a common equity across ...
Prudhoe Bay, there still may be different royalty
provisions for the different pools and the
participating areas are the way we identify the pools.
6:33:10 PM
MR. VAN DYKE commented that slide 12 contains a stratigraphic
column depicting the types of geology at different depths of the
North Slope. In response to Chair Kohring, he confirmed that
the heavy oil is mostly found in sandstone.
MR. VAN DYKE said that slide 13 contains a map of satellite
fields in the Prudhoe Bay unit. He pointed out that the
satellites are at the west end of the unit and they overlie each
other, so the same drills sites can be used to drill multiple
wells. He remarked that the sharing of facilities is very
important.
MR. VAN DYKE explained that slide 14 titled, "Multilateral
Wellbore Completions", depicts a "fancy multilateral well" with
several arms that could be reaching the same area in a given oil
pool or different pools entirely. He commented that this type
of well is expensive to drill, but it produces a lot more oil
than a conventional well.
6:36:02 PM
MR. VAN DYKE said:
Slide 15 ... shows the different satellite pools
within Prudhoe Bay unit ... from a map view or
location surface view. Most of the satellites are out
there at the west end and production goes into
Gathering Center 2 along with a lot of the production
from the main pool at Prudhoe Bay. Then the gas is
all sent over to the ... central gas facility in the
central compression plant.
6:36:40 PM
MR. VAN DYKE returned to the beginning of the handout and
stated:
I tried to jot down some ideas on what drives
investment ... up on the North Slope ... and I don't
think there's any doubt about it that it's the chance
to make a profit, at least under the system we have
here in Alaska. ... [The State of Alaska leases] ...
land out to third parties and ... to for-profit
companies, and they're up there to make some money.
... It's no different than WalMart or Alaska Airlines.
They're accountable to their shareholders. ... What's
different in their business model is that they have to
go in assuming that there are going to be a lot of
failures, at least in the exploration stage ... and a
few successes. But if that ... is built into your
business model to start with, you can still be quite
successful; you just have to plan that you're going to
drill some dry holes. That's just part of the
business.
6:37:45 PM
CHAIR KOHRING commented, "Let's hope they continue to achieve
good profits but let's make it win-win so we can get some money
as well for our treasury."
MR. VAN DYKE gave a brief overview of the oil and gas lifecycle:
exploration, delineation, development, and then production.
MR. VAN DYKE, in response to Chair Kohring, stated that he was
not sure when wells began to be drilled on the North Slope, but
he said that the drilling started south of Prudhoe Bay. He said
that [the explorers] got their leads in the Brooks Range and
then followed them north.
MR. VAN DYKE returned to the topic of the oil and gas life cycle
and said:
This life cycle ... is repeated over and over and you
build on your existing infrastructure and you build on
your added knowledge. You gain information over time
and in some cases you gain a competitive position, ...
if you have better contracts with drilling
contractors, or you brought your own drilling rig up
there, maybe you can do business a little better than
the guy next door. ... And this is what we're trying
to foster: getting more people involved in this cycle
and ... keeping it continuing.... The facts change,
conditions change. ... We have a lot of people that
buy leases; most of those leases don't get drilled.
If you look at the statistics, ... most leases at the
end of their primary term ... expire; they come back
to the state and we lease them again. And then some
of them do get drilled and they're dry holes, and they
get turned back in to the state. Some projects
progress towards development, but just don't ever
quite get there. And then some projects go into
development and they get shut in because something
happened, because of the risk involved and production
just wasn't quite what folks thought. ...
Opportunities change, business practices change, and
economics change. I don't think it's something that
you want to fault the Alaska system for, it's just
part of the normal business practice.
6:40:43 PM
MR. VAN DYKE then turned to the topic of risk on the North
Slope. He remarked that during the exploration phase there is a
lot more risk because, regardless of predictions, a company
doesn't really know if there is oil until it drills a well. He
stated that for people in the oil and gas business, risk is a
part of everyday life, and companies are constantly benchmarking
and revisiting their operations because conditions change over
time. He said:
An enhanced oil recovery project that didn't look
profitable a few years ago maybe does look profitable
now. Or in-field drilling opportunities. Or these
Prudhoe Bay satellites. ... It's not that the oil
wasn't there; ... there wasn't a commercial way to get
it produced and use the surface facilities at the
time. There is today and those satellites are
producing ... close to 50,000 barrels a day.
6:42:29 PM
MR. VAN DYKE continued discussing the topics outlined in the
handout. He remarked:
What's going to separate the winners from the losers?
Certainly there is no simple answer to that. But
again I think, under the system we have today, [oil
and gas companies] are going to have to make a profit.
If they're going to move forward on a project or
expand a project they're going to do it because they
can make a profit. ... Different companies measure
profit differently. There's all sorts of
indicators.... When [the companies] are looking at a
project, whether it's a satellite pool or an
exploration well, ... they're going to look at ... the
size of the oil accumulation, because that's going to
affect their total cash flow. They're going to look
at the flow rates from the wells, because ... that
affects the timing of the cash flow.... They're also
going to look at the ... location [relative] to
existing infrastructure and access to existing
infrastructure. ... Things on the North Slope have
changed in that regard recently too, because there are
these facility-sharing agreements now, there are
common equity agreements. The infrastructure is
available now, and there are ... commercial contracts
out there where third parties can understand what it
will take to access that infrastructure.
6:43:49 PM
MR. VAN DYKE remarked that there are some big oilfields on the
North Slope that have not been developed; they are offshore of
ANWR in relatively deep water in the federal Outer Continental
Shelf (OCS) area. He opined that the fields are big but very
remote and therefore will be expensive to develop, "and so today
they just sit there." Additionally there is some very viscous
oil in the Ugnu formation around Kuparuk, Prudhoe Bay, and Milne
Point, but he said that it's not economic to develop today.
Returning to the topic of wells offshore of ANWR, he said,
"Those accumulations, probably even if they had a zero tax and a
zero royalty ... those fields are probably uneconomic to develop
today. ... There's not a whole lot the government can do other
than to pay someone to produce them."
6:45:34 PM
MR. VAN DYKE opined that oil and gas companies need to have a
good cash flow model that incorporates risk, and they need to
evaluate the risks properly. He commented that the companies
also need to make a profit, but profit is different for each
company. He said that the companies all forecast price
differently and evaluate the risks differently.
ADJOURNMENT
There being no further business before the committee, the House
Special Committee on Oil and Gas meeting was adjourned at
6:47:58 PM.
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