Legislature(2021 - 2022)BARNES 124

03/05/2021 01:00 PM RESOURCES

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01:03:16 PM Start
01:04:50 PM HB81
02:55:59 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
*+ HB 81 OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE TELECONFERENCED
Heard & Held
-- Testimony <Invitation Only> --
+ Bills Previously Heard/Scheduled TELECONFERENCED
                    ALASKA STATE LEGISLATURE                                                                                  
               HOUSE RESOURCES STANDING COMMITTEE                                                                             
                         March 5, 2021                                                                                          
                           1:03 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Representative Josiah Patkotak, Chair                                                                                           
Representative Grier Hopkins, Vice Chair                                                                                        
Representative Calvin Schrage                                                                                                   
Representative Sara Hannan                                                                                                      
Representative George Rauscher                                                                                                  
Representative Mike Cronk                                                                                                       
Representative Ronald Gillham                                                                                                   
Representative Tom McKay                                                                                                        
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
Representative Zack Fields                                                                                                      
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
HOUSE BILL NO. 81                                                                                                               
"An Act authorizing the commissioner of natural resources to                                                                    
modify a net profit share lease."                                                                                               
                                                                                                                                
     - HEARD & HELD                                                                                                             
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: HB  81                                                                                                                  
SHORT TITLE: OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE                                                                          
SPONSOR(s): RULES BY REQUEST OF THE GOVERNOR                                                                                    
                                                                                                                                
02/18/21       (H)       READ THE FIRST TIME - REFERRALS                                                                        
02/18/21       (H)       RES, FIN                                                                                               
03/05/21       (H)       RES AT 1:00 PM BARNES 124                                                                              
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
JHONNY MEZA, Commercial Section Manager                                                                                         
Division of Oil and Gas                                                                                                         
Department of Natural Resources                                                                                                 
Anchorage, Alaska                                                                                                               
POSITION STATEMENT:  Gave a PowerPoint presentation on HB 81.                                                                 
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
1:03:16 PM                                                                                                                    
                                                                                                                                
CHAIR  JOSIAH  PATKOTAK  called   the  House  Resources  Standing                                                             
Committee meeting  to order at 01:03  p.m. Representatives McKay,                                                               
Rauscher, Hopkins,  Hannan, Gillham, Schrage, and  Patkotak, were                                                               
present at the  call to order.  Representative Cronk  arrived  by                                                               
teleconference as the meeting was in progress.                                                                                  
                                                                                                                                
        HB 81-OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE                                                                     
                                                                                                                                
1:04:50 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK  announced that the  only order of  business would                                                               
be HOUSE  BILL NO.  81, "An Act  authorizing the  commissioner of                                                               
natural resources to modify a net profit share lease."                                                                          
                                                                                                                                
1:05:47 PM                                                                                                                    
                                                                                                                                
JHONNY  MEZA, Commercial  Section  Manager, Division  of Oil  and                                                               
Gas,  Department  of  Natural  Resources,   described  HB  81  as                                                               
legislation that  would "modify  certain aspects of  the existing                                                               
statutes  for  royalty modifications."    He  began a  PowerPoint                                                               
presentation  on  HB 81  [hard  copy  included in  the  committee                                                               
packet] and turned attention to  slide 2, titled "OUTLINE", which                                                               
read as follows [original punctuation provided]:                                                                                
                                                                                                                                
     I. Overview of Net Profit Share Leases                                                                                     
                                                                                                                                
     II. Why DNR would modify the royalty rate?                                                                                 
                                                                                                                                
     III. Why DNR would modify the net profit share rate?                                                                       
                                                                                                                                
     IV. Overview of the modification process                                                                                   
                                                                                                                                
     V. Appendix                                                                                                                
                                                                                                                                
MR. MEZA showed slide 3, titled  "I. OVERVIEW OF NET PROFIT SHARE                                                               
LEASES" and paraphrased  slide 4, titled "ROYALTY  AND NET PROFIT                                                               
SHARE," which read as follows [original punctuation provided]:                                                                  
                                                                                                                                
     1. What is royalty?                                                                                                        
     club In its role as owner  of the  hydrocarbons in  the                                                                    
     subsurface, and  in exchange for allowing  a lessee the                                                                    
     right to  explore and develop said  resource, the state                                                                    
     reserves for itself a percentage  of the gross value of                                                                    
     that resource when produced by the company.                                                                                
     club This percentage (the royalty rate) is established in                                                                  
     the oil and gas lease contract.                                                                                            
     club All oil and gas leases offered by the state have a                                                                    
     royalty provision.                                                                                                         
                                                                                                                                
     2. What is a net profit share?                                                                                             
     club For a small group of leases, the state, also acting                                                                   
     as resource owner, reserves for  itself, in addition to                                                                    
     royalty, a percentage of the profits from the lease.                                                                       
     club A lease with royalty and net profit share is called                                                                   
     a "Net Profit Share Lease."                                                                                                
     club The "sharing  of  net  profits"  occurs  once  the                                                                    
     exploration  and development  costs  allocated to  this                                                                    
     lease  are  recovered  through  the  revenues  (net  of                                                                    
     operating costs) from this lease.                                                                                          
                                                                                                                                
MR.  MEZA further  explained that  the company  pays the  state a                                                               
share  of the  profits, with  percentages ranging  from 30  to 79                                                               
percent.   He said that  while all oil  and gas leases  contain a                                                               
royalty  provision, only  26 leases  contain a  net profit  share                                                               
provision, referred to as net profit share leases (NPSLs).                                                                      
                                                                                                                                
1:09:40 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HANNAN referred  to the  26 NPSLs  and asked  how                                                               
many total leases exist.                                                                                                        
                                                                                                                                
MR. MEZA  answered that  the NPSLs represent  a tiny  minority of                                                               
all oil and gas leases.                                                                                                         
                                                                                                                                
1:10:24 PM                                                                                                                    
                                                                                                                                
MR.  MEZA presented  slide 5,  which includes  a table  comparing                                                               
royalty,  production tax,  net profit  share, and  profit to  the                                                               
lessee at  various times throughout  the life  of the lease.   He                                                               
explained that the  state, acting in its role  as resource owner,                                                               
establishes  the  royalty  and  net profit  share  rates  in  the                                                               
contracts.   Acting  in its  role  as sovereign,  the state  also                                                               
determines the production tax according  to state law.  While the                                                               
commissioner  of the  Department  of Natural  Resources (DNR)  is                                                               
currently authorized under AS 38.05.180(j)  to modify the royalty                                                               
rate,  there is  no such  statute  pertaining to  the net  profit                                                               
share rate;  HB 81  is proposing  that net  profit share  rate be                                                               
included in  the royalty  modification statute.   Mr.  Meza noted                                                               
that net  profit share rate  has been  modified for one  lease by                                                               
legislative action and stressed  that production tax would remain                                                               
unaffected .   He went on to explain that  royalty is assessed on                                                               
the  gross value  of production  from a  lease, which  is key  in                                                               
differentiating  it from  the  net profit  share  rate, which  is                                                               
assessed on  the profits  net of  any associated  costs; however,                                                               
royalty  payments begin  immediately at  the start  of commercial                                                               
production, while net profit share  payments begin when the lease                                                               
reaches  the "payout"  stage, which  is when  two conditions  are                                                               
met: resources  are produced,  and some  of the  costs associated                                                               
with exploration and  development have been recovered.   Mr. Meza                                                               
concluded  the explanation  of this  slide by  explaining that  a                                                               
rate  of  net  profit  sharing  is assessed  for  each  NPSL;  in                                                               
contrast, the  profit received by  the lessee is  likely assessed                                                               
at the project level and may result from a collection of leases.                                                                
                                                                                                                                
1:15:04 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE   HANNAN   noted   the  reference   to   the   DNR                                                               
commissioner's statutory authority to  modify royalties and asked                                                               
how often modification occurs.  She  also referred to the one net                                                               
profit  share modification  passed by  the legislature  and asked                                                               
about the circumstances.                                                                                                        
                                                                                                                                
MR.  MEZA responded  that of  the 1,598  current leases,  461 are                                                               
producing,  and  there  have  been  eight  requests  for  royalty                                                               
modification  by the  lessees.   He also  said that  the specific                                                               
legislative  action  to  modify  a  net  profit  share  would  be                                                               
discussed in a later slide.                                                                                                     
                                                                                                                                
1:17:19 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HOPKINS  asked  whether  the  royalty  rates  are                                                               
public information.                                                                                                             
                                                                                                                                
MR. MEZA replied that they are.                                                                                                 
                                                                                                                                
REPRESENTATIVE  HOPKINS followed  up to  ask whether  it is  also                                                               
made public when NPSLs reach the payoff stage.                                                                                  
                                                                                                                                
MR. MEZA answered that, because  the state receives payments, the                                                               
information is made public.                                                                                                     
                                                                                                                                
1:18:03 PM                                                                                                                    
                                                                                                                                
MR  MEZA presented  slide 6,  titled "NET  PROFIT SHARE  LEASES",                                                               
which illustrates  an example of an  NPSL.  By statute,  he said,                                                               
the  DNR commissioner  has the  authority  to issue  oil and  gas                                                               
leases  via a  competitive  bidding process;  different types  of                                                               
leases may be offered, those  with a royalty component being most                                                               
common.    Leases  that  have  both a  royalty  component  and  a                                                               
provision  for net  profit  sharing are  the  NPSLs; the  example                                                               
illustrated on this  slide has a royalty provision  of 20 percent                                                               
and a  net profit sharing  rate of 93.2  percent.  The  winner of                                                               
this lease  was the bidder who  offered the highest share  of net                                                               
profit.                                                                                                                         
                                                                                                                                
1:20:10 PM                                                                                                                    
                                                                                                                                
MR. MEZA presented slide 7,  a graphical illustration comparing a                                                               
lease  with only  a  royalty  component, and  an  NPSL with  both                                                               
royalty  and  net profit  share  components.   Both  leases  have                                                               
identical    costs    for   capital    expenditures,    operating                                                               
expenditures,  transportation costs,  and  royalty; in  contrast,                                                               
the NPSL lease shows the net  profit share to the State of Alaska                                                               
in its  role as resource  owner and  lower production tax  to the                                                               
State in  its role  as sovereign.   As a  result, the  NPSL lease                                                               
shows less profit retained by the lessee.                                                                                       
                                                                                                                                
1:22:42 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  RAUSCHER referred  to  an earlier  remark by  Mr.                                                               
Meza  and asked  if  it  was correct  that  eight companies  have                                                               
requested this legislation.                                                                                                     
                                                                                                                                
MR MEZA  clarified that DNR  has received eight  applications for                                                               
royalty modifications since the statute was enacted in 1995.                                                                    
                                                                                                                                
REPRESENTATIVE  RAUSCHER asked  why a  company would  want to  do                                                               
that.                                                                                                                           
                                                                                                                                
MR. MEZA  replied that this  question would be answered  later in                                                               
the presentation.                                                                                                               
                                                                                                                                
1:23:44 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  MCKAY stated  that  he believes  the  idea is  to                                                               
"help marginal  leases" get back  into production by  writing off                                                               
development costs against the royalty.                                                                                          
                                                                                                                                
MR. MEZA said that Representative  McKay is correct, and that the                                                               
objective  of  DNR  is  to   "prevent  resources  from  remaining                                                               
stranded."                                                                                                                      
                                                                                                                                
CHAIR  PATKOTAK  referred  to Representative  Rauscher's  earlier                                                               
assertion  that eight  companies requested  this legislation  and                                                               
clarified  that the  companies requested  changes to  their lease                                                               
terms; they don't necessarily support this legislation.                                                                         
                                                                                                                                
MR. MEZA further  clarified that the eight  applications were for                                                               
royalty modifications.                                                                                                          
                                                                                                                                
1:25:07 PM                                                                                                                    
                                                                                                                                
MR.  MEZA presented  slide 8,  titled  "MAP OF  NET PROFIT  SHARE                                                               
LEASES", which showed a map of  the North Slope with the existing                                                               
oil and gas units and distinguishing  the 26 NPSLs.  He explained                                                               
that an oil  and gas unit contains a set  of leases, either NPSLs                                                               
or leases  with only  a royalty  component.  He  said that  it is                                                               
worth noting  that there also  exist leases, issued in  the 1970s                                                               
and 1980s, which are  not a part of any unit  and have net profit                                                               
shares rates ranging from 30 to 79 percent.                                                                                     
                                                                                                                                
1:27:39 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HANNAN  asked for  further explanation of  the map                                                               
and  referred specifically  to the  numbered leases  on the  Duck                                                               
Island  Unit.   She  asked  whether the  two  NPSLs  in the  unit                                                               
comprised the entirety  of the leases and or if  a portion of the                                                               
tract was not an NPSL.                                                                                                          
                                                                                                                                
MR. MEZA  answered that the map  was showing only the  NPSLs with                                                               
the  remaining area,  shown  in  yellow, containing  royalty-only                                                               
leases.                                                                                                                         
                                                                                                                                
REPRESENTATIVE HANNAN  followed up to  ask whether it's  the same                                                               
company that owns both the royalty-only leases and the NPSLs.                                                                   
                                                                                                                                
MR. MEZA replied that while  different ownership of the leases is                                                               
possible, it's most commonly the same owner.                                                                                    
                                                                                                                                
1:28:56 PM                                                                                                                    
                                                                                                                                
MR. MEZA finished  his explanation of the map with  the note that                                                               
some of  the NPSLs have  already paid  a total of  $1.17 billion;                                                               
others  have not  yet shared  profits  because they  are not  yet                                                               
producing or have not yet reached the payout stage.                                                                             
                                                                                                                                
MR.  MEZA continued  to  slide  9, "26  ACTIVE  NET PROFIT  SHARE                                                               
LEASES ON THE  NORTH SLOPE," which showed for each  lease the net                                                               
profit share  rate, royalty rate,  whether the lease  has reached                                                               
the payout  stage, and the  cumulative net profit sharing  to the                                                               
state.  He noted that most of  the NPSLs were issued in the 1970s                                                               
and  1980s, while  three were  established more  recently due  to                                                               
"lease  segregation,"   which  means   the  original   lease  was                                                               
partitioned into two leases.   He said HB 81 proposes authorizing                                                               
the DNR commissioner to modify both  the royalty rate and the net                                                               
profit  share rate  if DNR  finds that  doing so  is in  the best                                                               
interest of the state.  The  modification of the net profit share                                                               
rate  would comprise  a temporary  reduction of  the rate  with a                                                               
gradual  increase under  certain  conditions,  to be  illustrated                                                               
later in the presentation.                                                                                                      
                                                                                                                                
1:31:30 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HOPKINS  asked whether  there is a  definition for                                                               
"in the best interest of the state."                                                                                            
                                                                                                                                
MR.  MEZA answered  that  the  state is  mandated  by statute  to                                                               
maximize the  value of the  resources; by considering  royalty or                                                               
net  profit  share  modifications,   the  goal  is  to  encourage                                                               
additional  production of  leases  which  would otherwise  remain                                                               
stranded.                                                                                                                       
                                                                                                                                
REPRESENTATIVE HOPKINS asked whether  the goal is more production                                                               
versus a higher monetary value per barrel.                                                                                      
                                                                                                                                
MR. MEZA responded  that without modification to  the rates there                                                               
would be no production, and more production means more revenue.                                                                 
                                                                                                                                
REPRESENTATIVE HOPKINS referred  to slide 9 and noted  that 14 of                                                               
the 26 leases have not yet  reach payout stage.  He asked whether                                                               
all 26  leases would be  eligible for modification or  only those                                                               
that have reached the payout stage.                                                                                             
                                                                                                                                
MR. MEZA  answered that HB  81 doesn't specify a  particular case                                                               
for modification but noted  that Representative Hopkins' question                                                               
makes  sense.    He  said  that   the  bill  is  intended  to  be                                                               
comprehensive, and that it would  immediately impact those leases                                                               
currently in  the payout stage  and would have future  impacts on                                                               
leases not yet in that stage.                                                                                                   
                                                                                                                                
1:34:15 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HANNAN referred specifically  to the Point Thomson                                                               
Unit as  having the oldest  lease and  asked Mr. Meza  to explain                                                               
why that lease hasn't paid the net profit share.                                                                                
                                                                                                                                
MR. MEZA  answered that the  Point Thomson unit  began production                                                               
in 2016  and is  in a  group of  leases that  do not  include any                                                               
NPSLs.   He  said  that  when a  company  considers applying  for                                                               
royalty or net profit share  modification, a convincing and clear                                                               
plan must  be provided to  DNR showing that a  modification would                                                               
improve  the lease's  economic viability  for future  production.                                                               
He said DNR analyzes and reviews all applications.                                                                              
                                                                                                                                
REPRESENTATIVE HANNAN  asked, "Did  you say  that there  are some                                                               
leases  in Point  Thomson that  are in  production, but  they are                                                               
royalty agreements?"                                                                                                            
                                                                                                                                
MR.  MEZA  replied  that  the leases  which  are  producing  only                                                               
contain the royalty component.                                                                                                  
                                                                                                                                
1:37:54 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE MCKAY  explained that  Exxon was building  out the                                                               
infrastructure in the Point Thomson  area, which is why there was                                                               
no production for  so many years after the first  issuance of the                                                               
lease.                                                                                                                          
                                                                                                                                
MR.  MEZA  told  the  committee  that  Representative  McKay  was                                                               
correct.                                                                                                                        
                                                                                                                                
1:38:41 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SCHRAGE asked  whether it's  correct to  say that                                                               
the proposed bill would allow  the adjustment of NPSLs for fields                                                               
that are  in production as  well as  those that have  not reached                                                               
the payout stage.                                                                                                               
                                                                                                                                
MR.  MEZA answered  that is  correct,  and explained  that HB  81                                                               
would  allow the  lessee  to apply  for  modification of  royalty                                                               
and/or  net  profit share  regardless  of  whether the  lease  is                                                               
producing  or  not,  because the  statute  "contemplates  clearly                                                               
defined scenarios under  which an applicant needs  to support its                                                               
application."   He  said that  the bill  is constrained  to apply                                                               
only  to specific  scenarios under  which  modification might  be                                                               
considered.                                                                                                                     
                                                                                                                                
REPRESENTATIVE  SCHRAGE  asked  whether  it would  be  a  correct                                                               
assumption that  "we would  be targeting  those fields  that have                                                               
not reached that payout stage  such that by modifying that profit                                                               
sharing  agreement,  economically,  they would  be  motivated  or                                                               
incentivized to have output and begin production."                                                                              
                                                                                                                                
MR.  MEZA replied  that Representative  Schrage's statement  is a                                                               
possibility and  that it could encourage  incremental production,                                                               
with  associated incremental  revenues, from  both producing  and                                                               
non-producing leases.                                                                                                           
                                                                                                                                
1:40:35 PM                                                                                                                    
                                                                                                                                
CHAIR  PATKOTAK  surmised  that   HB  81  would  be  establishing                                                               
parameters within  which the state  may operate  when considering                                                               
modifications to lease terms.                                                                                                   
                                                                                                                                
MR. MEZA replied, "That is correct."                                                                                            
                                                                                                                                
1:41:26 PM                                                                                                                    
                                                                                                                                
MR.  MEZA presented  slide 10,  "MODIFICATION  OF NORTHSTAR  UNIT                                                               
NPSLS THROUGH  LEGISLATIVE ACTION  IN 1996," showing  four leases                                                               
in the  Northstar Unit  originally offered in  1980 with  a fixed                                                               
royalty rate  of 20 percent;  companies bid on the  leases, which                                                               
were awarded to  those who offered to pay the  highest net profit                                                               
share  rate.    The  lessee, British  Petroleum  (BP),  evaluated                                                               
future development of the lease  and informed DNR of the expected                                                               
viability of  the project, given the  costs.  In 1996  DNR and BP                                                               
negotiated net  profit share and royalty  rate modification terms                                                               
and proposed changes  to the legislature, which passed  a bill to                                                               
modify both  rates.   The legislature found  that unless  the net                                                               
profit share  rates were modified  the unit would be  unlikely to                                                               
produce until  2002, if  at all.   The  purpose of  modifying the                                                               
rates, Mr. Meza explained, was  to encourage production in a case                                                               
where  none  would otherwise  occur,  which  would result  in  no                                                               
revenue to the state.                                                                                                           
                                                                                                                                
1:43:25 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK  asked whether  it is  currently incumbent  on the                                                               
legislature to change both royalty and net profit share rates.                                                                  
                                                                                                                                
MR.  MEZA  explained  that  the  DNR  commissioner  is  currently                                                               
authorized by statute to modify  royalty rates, if DNR finds that                                                               
the  modification is  in  the best  interest of  the  state.   In                                                               
contrast, net  profit share  rate modifications  must be  done by                                                               
legislative  action.   He  said  HB 81  proposes  giving the  DNR                                                               
commissioner the  authority to modify  the net profit  share rate                                                               
under the statute  that allows modification of  the royalty rate.                                                               
In  response to  Chair  Patkotak,  he relayed  that  in 1995  the                                                               
legislature enacted the statute  the allowed the DNR commissioner                                                               
to modify royalty  rates because the net profit  share rates were                                                               
not  eligible for  modification under  statute.   The net  profit                                                               
share rates  on the BP  leases were modified  through legislative                                                               
action in 1996.                                                                                                                 
                                                                                                                                
1:46:03 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  MCKAY  stated   his  belief  that  ConocoPhillips                                                               
Alaska, Inc. originally owned the  Northstar Unit leases and sold                                                               
them to BP, which then approached  the state for net profit share                                                               
modification.   He said that if  the field or pool  is "shut in,"                                                               
then  production   may  never  occur  or   may  otherwise  become                                                               
uneconomic.                                                                                                                     
                                                                                                                                
MR MEZA replied, "That is precisely correct."                                                                                   
                                                                                                                                
1:47:41 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HANNAN asked  whether the  Northstar leases  have                                                               
produced as expected  since the modification was made.   She also                                                               
asked  whether these  are the  leases  that recently  transferred                                                               
from BP to Hilcorp Alaska, LLC.                                                                                                 
                                                                                                                                
MR.  MEZA replied  that production  began  in 2002  and has  been                                                               
approximately 178 million barrels of oil.                                                                                       
                                                                                                                                
1:49:12 PM                                                                                                                    
                                                                                                                                
MR. MEZA  introduced the  next section  of the  presentation with                                                               
slide 11, "WHY  DNR WOULD MODIFY THE ROYALTY  RATE" and proceeded                                                               
immediately  to   slide  12,   "STRANDED  RESOURCES   MEANS  ZERO                                                               
PRODUCTION AND ZERO  REVENUES TO THE STATE,"  which illustrates a                                                               
2005  case in  which DNR  granted a  modification.   He explained                                                               
that the  Oooguruk unit has  four NPSLs and  several royalty-only                                                               
leases;  in its  application, the  developer, Pioneer,  said that                                                               
without  lower royalty  rates  the project  would  "fail to  meet                                                               
minimal economic  targets," thereby leaving the  project stranded                                                               
and providing no revenue  to the state.  He said  DNR did its own                                                               
analysis and agreed with that  assessment and allowed a temporary                                                               
reduction in  royalty rates  to 5 percent.   Production  began in                                                               
2008 and cumulative revenues to  the state have been $145 million                                                               
in royalties and $12 million in net profit sharing.                                                                             
                                                                                                                                
1:51:08 PM                                                                                                                    
                                                                                                                                
MR.  MEZA  continued  to  slide  13, "WHY  WOULD  DNR  ALLOW  THE                                                               
MODIFICATION OF  THE ROYALTY RATE?", which  demonstrates revenues                                                               
and expenditures over  time for two hypothetical  leases with and                                                               
without  royalty modifications.    The two  cases have  identical                                                               
development costs, operating costs,  and revenues; the production                                                               
tax, royalty rates, and net  profit sharing are considered in the                                                               
economic evaluation  for the  project.   From the  perspective of                                                               
the  lessee,  Mr. Meza  explained,  the  project without  royalty                                                               
modification  is  not  profitable,  so  "the  investment  is  not                                                               
sanctioned, resources  are stranded,  and the  projected revenues                                                               
to the state are not realized  and they become zero."  Maximizing                                                               
the value of  resources is in the best interest  of the state, so                                                               
reducing the  royalty rate in  turn leads to a  profitable enough                                                               
project.   In  this way,  resources are  produced, and  the state                                                               
realizes revenue.   Since  the leases  in this  hypothetical also                                                               
have  net  profit  sharing  components, Mr.  Meza  said,  "it  is                                                               
possible  that  the  same  goal   could  have  been  achieved  by                                                               
modifying the  net profit  share rather  than the  royalty rate,"                                                               
which would be possible under HB 81.                                                                                            
                                                                                                                                
1:54:13 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HOPKINS  asked at  what point  during the  life of                                                               
the lease there  would be a change in the  net profit share rate,                                                               
should HB 81 pass.                                                                                                              
                                                                                                                                
MR. MEZA  answered that the  only change  in this example  is the                                                               
royalty rate.   He said that in describing  this hypothetical the                                                               
question was posed, "Could DNR  have obtained a similar result of                                                               
incentivizing  the  investment  by,   instead  of  modifying  the                                                               
royalty, we modified the net profit sharing?".                                                                                  
                                                                                                                                
REPRESENTATIVE   HOPKINS  asked   whether   there   would  be   a                                                               
demonstration showing  a point  in the  project when  a developer                                                               
would understand  that the field  is unprofitable, leading  it to                                                               
apply for a net profit sharing modification.                                                                                    
                                                                                                                                
MR.  MEZA  replied  that  slides   24  and  25  would  show  that                                                               
possibility.                                                                                                                    
                                                                                                                                
1:56:05 PM                                                                                                                    
                                                                                                                                
MR. MEZA  continued to slide  14, titled "HISTORY OF  DNR ROYALTY                                                               
MODIFICATION APPLICATIONS."   This slide  is a chart  showing the                                                               
outcome  of  each  application for  royalty  modifications  since                                                               
1995.   Of  eight  applications, three  were  approved; two  were                                                               
denied;  and three  were withdrawn  by  the applicant.   The  new                                                               
terms  of  the  three  approved   leases  contained  a  provision                                                               
establishing the specific modification of  the rate.  In the case                                                               
of the  Oooguruk (Kuparuk  and Nuiqsut)  field, the  royalty rate                                                               
was  reduced to  5 percent  at  the beginning  of production  and                                                               
gradually increased  back to  its original  level when  the lease                                                               
reached the payout  stage.  For the Oooguruk  (Nuna Torok) field,                                                               
the modification  of royalty was  granted but the  company didn't                                                               
make   the   necessary   capital   investment;   therefore,   the                                                               
modification was rescinded.                                                                                                     
                                                                                                                                
1:58:03 PM                                                                                                                    
                                                                                                                                
CHAIR   PATKOTAK  stated   his  understanding   that  when   rate                                                               
modifications are  made there's  a clause that  specifies capital                                                               
investments are required.                                                                                                       
                                                                                                                                
MR. MEZA  answered that the  decision issued by the  DNR includes                                                               
"multiple  covenants  and  conditions"   in  order  to  keep  the                                                               
modification.                                                                                                                   
                                                                                                                                
1:58:51 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE   HOPKINS   asked   whether  the   sliding   scale                                                               
mechanisms are  unique to each  field or developer, and  he asked                                                               
whether  HB  81 would  allow  the  DNR commissioner  to  continue                                                               
having that latitude.                                                                                                           
                                                                                                                                
MR. MEZA  answered that HB  81 would maintain  the commissioner's                                                               
existing flexibility  in deciding the mechanism  for modification                                                               
and would not only maintain it,  but would expand it to modifying                                                               
the  net profit  share  rates  in NPSLs  if,  through DNR's  best                                                               
interest  finding,  including  public comment  and  presentation,                                                               
it's  found that  modification is  in  the best  interest of  the                                                               
state.                                                                                                                          
                                                                                                                                
REPRESENTATIVE HOPKINS  noted that  it wouldn't be  necessary for                                                               
the rate to go back up.                                                                                                         
                                                                                                                                
MR. MEZA replied  that it's possible to have a  case in which the                                                               
net profit share rate doesn't  need to return to original levels,                                                               
depending  on  the  project  in  question.   He  said  that  with                                                               
reference  to   the  NPSLs,  there  are   also  other  mechanisms                                                               
available.                                                                                                                      
                                                                                                                                
REPRESENTATIVE HOPKINS  said that  getting the  fields productive                                                               
is a good goal.                                                                                                                 
                                                                                                                                
2:02:32 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK asked for a  brief overview of what the parameters                                                               
are in determining eligibility for an NPSL modification.                                                                        
                                                                                                                                
MR. MEZA replied that a partial  answer to his question is in the                                                               
presentation and that he would provide further explanation.                                                                     
                                                                                                                                
CHAIR PATKOTAK  noted that  it would be  helpful in  phrasing the                                                               
bill and to show that there are checks and balances.                                                                            
                                                                                                                                
2:03:55 PM                                                                                                                    
                                                                                                                                
MR. MEZA  explained that when  DNR proposes a  modification, it's                                                               
mandated  that the  department publish  a best  interest finding,                                                               
which is  subject to  a public  comment period,  and to  "offer a                                                               
presentation"  to the  legislative  budget  and audit  committee,                                                               
which will be described later in the meeting.                                                                                   
                                                                                                                                
MR.  MESA   introduced  the  third  section   of  his  PowerPoint                                                               
presentation, "III.  WHY DNR  WOULD MODIFY  THE NET  PROFIT SHARE                                                               
RATE?" and  paraphrased slide 16, titled  "1. INCREASE PRODUCTION                                                               
FROM  OTHERWISE  STRANDED  RESOURCES,"   which  read  as  follows                                                               
[original punctuation provided]:                                                                                                
                                                                                                                                
     A.  Under  certain  circumstances,  even  with  royalty                                                                    
     modification,  it is  possible  for  continuing or  for                                                                    
     incremental production  from pools which  contain NPSLs                                                                    
     to be stranded.                                                                                                            
          ?  If resources  are stranded  ? Project  does not                                                                    
     happen ? No royalty or net profit sharing to the State                                                                     
          ? Modification  of the net  profit share  may make                                                                    
     such production economic.                                                                                                  
                                                                                                                                
     B. Modification of royalty and/or  net profit share for                                                                    
     pools which  would otherwise  be stranded  could extend                                                                    
     the life of such field and other existing fields.                                                                          
          ? This  would result in additional  royalties, net                                                                    
     profit  share, taxes,  etc. that  the  State would  not                                                                    
     otherwise receive.                                                                                                         
                                                                                                                                
2:06:12 PM                                                                                                                    
                                                                                                                                
MR.  MESA  paraphrased  slide 17,  "2.  FLEXIBILITY  FOR  ROYALTY                                                               
MODIFICATIONS,"  which  read  as  follows  [original  punctuation                                                               
provided]:                                                                                                                      
                                                                                                                                
     Currently,  DNR  can modify  royalty  but  not the  net                                                                    
     profit share.                                                                                                              
          A. NPSL  Modifications would give  DNR flexibility                                                                    
     to  elect targeted  reductions and  could  be a  useful                                                                    
     tool in environments of high oil price volatility.                                                                         
               ? Under  certain circumstances, it may  be in                                                                    
     the best  interest of  the State  to modify  net profit                                                                    
     share instead of royalty.                                                                                                  
               ? Royalties  are paid sooner than  net profit                                                                    
     shares  and are  more predicable  over the  life of  an                                                                    
     investment.                                                                                                                
               ? Alternatively,  smaller reductions  in both                                                                    
     royalty rate and net profit  share may allow for a more                                                                    
     advantageous "blended" incentive structure.                                                                                
                                                                                                                                
          B.   NPSL  Modifications   would  enable   DNR  to                                                                    
     increase net  profit shares in scenarios  where DNR can                                                                    
     structure  potential payback  of  foregone revenues  in                                                                    
     the event of higher prices or production levels.                                                                           
                                                                                                                                
2:07:52 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SCHRAGE   asked  whether  he's  correct   in  his                                                               
understanding  that  in  an economic  environment  with  low  oil                                                               
prices a  royalty reduction  would allow  a production  to begin,                                                               
but  the  state would  lose  money  should oil  prices  increase;                                                               
allowing adjustment to the net  profit share rate would mean that                                                               
in this case, the state receives increased revenue later.                                                                       
                                                                                                                                
MR. MEZA  responded that Representative Schrage's  summary is one                                                               
possible scenario  showing the "valuable flexibility"  that HB 81                                                               
would allow the DNR commissioner.                                                                                               
                                                                                                                                
2:09:04 PM                                                                                                                    
                                                                                                                                
MR.  MEZA   presented  slide  18,   "WHY  WOULD  DNR   ALLOW  THE                                                               
MODIFICATION  OF  THE NET  PROFIT  SHARE  RATE?   A  HYPOTHETICAL                                                               
EXAMPLE," which  shows two  graphs representing  a case  in which                                                               
production is  defined by a set  of leases with both  royalty and                                                               
net profit sharing,  and another case in which  it's defined only                                                               
by  net  profit  sharing,  with   profitability  shown  from  the                                                               
perspective of  the lessee.   An evaluation of the  investment is                                                               
determined in  "year zero" (a  point at which no  expenditures or                                                               
revenues  have existed),  including  a  combination of  variables                                                               
including  production,  price,  and cost,  to  determine  whether                                                               
investment should  occur; if projections show  a negative return,                                                               
investment  will  not   take  place.    Mr.   Meza  directed  the                                                               
committee's  attention to  the graph,  titled "20%  of production                                                               
allocated  to  the NPSLs"  where  a  light blue  line  represents                                                               
profits  with  no modification  to  the  rates, showing  negative                                                               
value  for the  project.   By  modifying only  the royalty  rate,                                                               
shown by  a dotted orange line,  the value becomes positive.   By                                                               
modifying only the net profit share  rate, as shown by the dashed                                                               
blue line, the  project likewise becomes more  valuable than with                                                               
no  modifications.    Mr.  Meza  then  directed  the  committee's                                                               
attention  to   the  other  graph  titled   "100%  of  production                                                               
allocated to the NPSLs," which  shows modification of either rate                                                               
by  itself  is  not  enough  to  make  the  project  economically                                                               
feasible,  thereby changing  the  company's investment  decision;                                                               
only combined modification of royalty  and net profit share rates                                                               
make the  project economic.   When  granting a  modification, Mr.                                                               
Meza explained,  the objective  is not to  guarantee a  profit to                                                               
the company, but  to incentivize the company  to sanction capital                                                               
investment to  develop and  produce the  resources.   Included on                                                               
the   slide  was   the  following   note  [original   punctuation                                                               
provided]:                                                                                                                      
                                                                                                                                
     The State  may find that,  to make a  project economic,                                                                    
     it is in its best interest to?                                                                                             
          A. Modify  only the  net profit share  rate rather                                                                    
     than the  royalty rate  without giving  up too  much of                                                                    
     its potential revenues                                                                                                     
          B. Modify  both if  the modification of  either is                                                                    
     not  enough to  affect the  investment decision  of the                                                                    
     lessee                                                                                                                     
                                                                                                                                
2:12:36 PM                                                                                                                    
                                                                                                                                
MR. MEZA paraphrased  slide 19, " 3. STREAMLINE  PROCESS FOR NPSL                                                               
MODIFICATIONS,"  which  read  as  follows  [original  punctuation                                                               
provided]:                                                                                                                      
                                                                                                                                
     A.  Current  process to  modify  NPSLs  is for  DNR  to                                                                    
     negotiate  a modification  package and  submit proposal                                                                    
     for legislative action.  ? In  1996, four NPSLs  in the                                                                    
     Northstar  Unit   were  modified  to   a  sliding-scale                                                                    
     royalty.                                                                                                                   
          ? The Legislature ratified  the modification in HB
     548 (Chapter 139 SLA 96).                                                                                                  
          ?   The   Alaska    Supreme   Court   upheld   the                                                                    
     modification in  Baxley v. State, 958  P.2d 422 (Alaska                                                                    
     1998).                                                                                                                     
                                                                                                                                
     B.  Providing for  NPSL Modification  in statute  would                                                                    
     streamline  NPSL modification  process, while  allowing                                                                    
      for the Legislature to set conditions and limits on                                                                       
     NPSL Modifications.                                                                                                        
                                                                                                                                
     C.  As  with  Royalty Modification,  NPSL  Modification                                                                    
     decisions are  reported to  the Legislature,  which may                                                                    
     require   hearings  or   take  additional   legislative                                                                    
     action.                                                                                                                    
                                                                                                                                
2:13:52 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HANNAN asked  whether other  administrations have                                                               
proposed similar  legislation since 1996  when the four  NPSLs in                                                               
the Northstar Unit were modified.                                                                                               
                                                                                                                                
MR. MEZA said that he does not know of any previous legislation.                                                                
                                                                                                                                
2:14:21 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE SCHRAGE said that  modification of the rates seems                                                               
to have merit and noted  that "we've proven that these agreements                                                               
can be changed  through the legislative process"  and asked about                                                               
the  advantage  to  giving  DNR the  flexibility  in  making  the                                                               
decisions, rather than continuing using the legislative process.                                                                
                                                                                                                                
MR.  MEZA  replied  that the  current  statute  for  modification                                                               
establishes the process that DNR  must follow for complicated and                                                               
detailed financial  and technical information;  while legislative                                                               
review  is  a   possibility,  HB  81  proposes   giving  the  DNR                                                               
commissioner  the authority  to carry  out that  process, publish                                                               
the findings for public comment,  and present to the legislature.                                                               
He  also  noted  that  in many  cases  the  applications  contain                                                               
sensitive and  confidential information  meant solely  for review                                                               
by DNR.                                                                                                                         
                                                                                                                                
2:16:31 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HOPKINS  referred  to the  "royalty  modification                                                               
checkbox" currently required under  statute and asked whether the                                                               
checkboxes would be  in statute under HB 81 or  in regulations by                                                               
DNR.                                                                                                                            
                                                                                                                                
MR.  MEZA  replied that  HB  81  does  not propose  changing  any                                                               
existing processes, in  fact, it proposes using  the same process                                                               
for reviewing  net profit  sharing modifications  as it  does for                                                               
royalty modifications.                                                                                                          
                                                                                                                                
REPRESENTATIVE   HOPKINS  surmised   that   net  profit   sharing                                                               
modifications would be in statute, not in regulations.                                                                          
                                                                                                                                
MR. MEZA said, "That is correct."                                                                                               
                                                                                                                                
2:17:55 PM                                                                                                                    
                                                                                                                                
MR.  MEZA  presented   the  fourth  and  final   section  of  the                                                               
presentation  with slide  20, "IV.  OVERVIEW OF  THE MODIFICATION                                                               
PROCESS,"  and proceeded  immediately to  paraphrase slide  21, "                                                               
WHAT  HB  81  ACCOMPLISHES,"  which  read  as  follows  [original                                                               
punctuation provided]:                                                                                                          
                                                                                                                                
     1. Expand  the royalty modification process  to include                                                                    
     NPSLs:                                                                                                                     
          A.  Commissioner  would   have  the  authority  to                                                                    
     modify net  profit share  rates in  the same  manner as                                                                    
     royalty rates under AS 38.05.180(j).                                                                                       
               ?  Objective is  to  encourage production  of                                                                    
     otherwise stranded resources.                                                                                              
                                                                                                                                
     2. Other changes:                                                                                                          
          A. Creates  an additional qualifying  scenario for                                                                    
     modification of either royalty or NPSLs                                                                                    
               ?  For  producing  pools,  where  incremental                                                                    
     production  requires incremental  capital expenditures,                                                                    
     which,  in  the  absence   of  modification,  would  be                                                                    
     uneconomic.                                                                                                                
          B.   Clarifies   that   test   production   during                                                                    
     exploration does  not disqualify  a field or  pool from                                                                    
     royalty or NPSL modification based on new production.                                                                      
               ?     This     codifies    DNR's     existing                                                                    
     interpretation and  is offered  to resolve  a potential                                                                    
     ambiguity. It  does not constitute a  change in current                                                                    
     policy.                                                                                                                    
                                                                                                                                
MR.  MEZA paraphrased  slide 22,  "WHAT TYPE  OF MODIFICATION  IS                                                               
WARRANTED?",   which  read   as  follows   [original  punctuation                                                               
provided]:                                                                                                                      
                                                                                                                                
     A. Royalty  Modification is  capped at  certain minimum                                                                    
     royalty rates.                                                                                                             
          ? Five percent for  .180(j)(1)(A) or three percent                                                                    
     for .180(j)(1)(B)(C).                                                                                                      
                                                                                                                                
     B. The  proposed NPSL  modification also  establishes a                                                                    
     minimum net profit share of ten percent.                                                                                   
                                                                                                                                
     C. The  modification may  be based  on a  sliding scale                                                                    
     mechanism.                                                                                                                 
          ? It could  vary with the price of  oil, volume of                                                                    
     production, per-barrel costs, etc.                                                                                         
                                                                                                                                
     D. Modifications of royalty or  net profit share can be                                                                    
     either lower  or higher than the  original percentages.                                                                    
     (AS 38.180(j)(3))                                                                                                          
          ? In  certain circumstances, this would  allow DNR                                                                    
     to recapture  foregone royalties or net  profit revenue                                                                    
     if oil prices rise, or  even to participate in "upside"                                                                    
     price movements if DNR provides "downside" relief.                                                                         
                                                                                                                                
2:20:52 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK asked whether there's  a way for the state, rather                                                               
than the developer, to request a modification.                                                                                  
                                                                                                                                
MR.  MEZA   answered  that  the   current  statute   for  royalty                                                               
modification,   and  now   proposed   for   net  profit   sharing                                                               
modification,  specifies   application  by  the  lessee   due  to                                                               
requiring the inclusion of technical and financial information.                                                                 
                                                                                                                                
2:22:19 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  RAUSCHER surmised  that, without  an application,                                                               
DNR cannot initiate the modification process.                                                                                   
                                                                                                                                
MR. MEZA replied, "That is correct."                                                                                            
                                                                                                                                
2:23:10 PM                                                                                                                    
                                                                                                                                
MR.   MEZA   presented   slide  23,   "ELIGIBLE   SCENARIOS   FOR                                                               
MODIFICATION."   The first three scenarios  currently exist under                                                               
the current statute  for royalty modification; HB  81 would allow                                                               
net profit share  modifications in these scenarios as  well.  Mr.                                                               
Meza explained the  scenarios on the slide,  described as follows                                                               
[original punctuation provided]:                                                                                                
                                                                                                                                
     A. New  Production: If the  development of a  new field                                                                    
     or pool would not  be economic without modification, so                                                                    
     long as  the field or pool  is sufficiently delineated.                                                                    
     AS 38.05.180(j)(1)(A)                                                                                                      
                                                                                                                                
     B. Extend  Production: To prolong the  economic life of                                                                    
     a field  or pool when  rising per-barrel costs  (due to                                                                    
     declining   production   or   otherwise)   would   make                                                                    
     continuing  production   no  longer   economic  without                                                                    
     modification. AS 38.05.180(j)(1)(B)                                                                                        
                                                                                                                                
     C.  Restore Production:  To  reestablish production  of                                                                    
     shut-in  oil  or  gas  that   would  otherwise  not  be                                                                    
     economically   feasible    without   modification.   AS                                                                    
     38.05.180(j)(1)(C)                                                                                                         
                                                                                                                                
MR. MEZA explained  that HB 81 proposes adding  a fourth scenario                                                               
of  eligibility  for  modification,  which would  apply  to  both                                                               
royalty and  net profit share  modifications; illustrated  on the                                                               
slide  as   "scenario  D,"  which   read  as   follows  [original                                                               
punctuation provided]:                                                                                                          
                                                                                                                                
     D.  Incremental Production:  If incremental  production                                                                    
     from  producing  pools  requiring  incremental  capital                                                                    
     expenditures   is   uneconomic   in  the   absence   of                                                                    
     modification.                                                                                                              
                                                                                                                                
     Examples:  Expansion  of   existing  pools,  additional                                                                    
     drilling pads, enhanced oil recovery projects, etc.                                                                        
                                                                                                                                
MR.  MEZA   gave  additional  examples,  including   expanding  a                                                               
currently-producing  pool  by  drilling  new  wells  outside  the                                                               
boundaries  of  the  known  reservoir  and  a  project  targeting                                                               
incremental production  by building additional drilling  pads and                                                               
using an extended-reach  drilling rig.  He explained  that DNR is                                                               
attempting   to  unlock   additional  resources   which,  without                                                               
modification of the  rates, may be stranded;  extending the lives                                                               
of  existing   pools  means  reaching  existing   resources,  and                                                               
receiving  the associated  revenues,  without  creating a  larger                                                               
infrastructure footprint.                                                                                                       
                                                                                                                                
2:27:07 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE GILLHAM  asked whether the DNR  commissioner would                                                               
have   the  sole   authority  to   approve  an   application  for                                                               
modification.                                                                                                                   
                                                                                                                                
MR.  MEZA   replied  that  the  existing   statutes  for  royalty                                                               
modification allows  the commissioner sole authority  and include                                                               
a  significant  period  of  review  of  technical  and  financial                                                               
information.  He noted that HB 81 would not change that process.                                                                
                                                                                                                                
2:28:21 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HOPKINS  asked about  the original impetus  for HB
81, given that it's been  25 years since the legislative decision                                                               
for net profit share modification.                                                                                              
                                                                                                                                
MR. MEZA summed up his previous explanation.                                                                                    
                                                                                                                                
REPRESENTATIVE HOPKINS  said that he understands  that production                                                               
has  been declining  since approximately  1988, but  he wants  to                                                               
know from where the idea for the bill came.                                                                                     
                                                                                                                                
MR. MEZA said that he would look into it.                                                                                       
                                                                                                                                
2:31:04 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE HANNAN asked whether there  is a companion bill in                                                               
the Senate.                                                                                                                     
                                                                                                                                
MR.  MEZA replied  that  he  is not  aware  of  a companion  bill                                                               
addressing net  profit share rates,  although he proffered  SB 61                                                               
is a similar bill with the same goal.                                                                                           
                                                                                                                                
REPRESENTATIVE HANNAN asked  whether SB 61 had  been presented to                                                               
the Senate Resources Standing Committee.                                                                                        
                                                                                                                                
MR. MEZA answered that it had.                                                                                                  
                                                                                                                                
2:32:02 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK  offered his  assumption that  at this  time there                                                               
are no pending applications for modification.                                                                                   
                                                                                                                                
MR. MEZA told the committee that Chair Patkotak is correct.                                                                     
                                                                                                                                
2:32:20 PM                                                                                                                    
                                                                                                                                
MR.  MEZA  resumed  his presentation  with  slide  24,  "ELIGIBLE                                                               
SCENARIOS FOR MODIFICATION," which  shows two graphs representing                                                               
scenarios  A  and B  from  slide  23.    The graph  labeled  "New                                                               
Production"  illustrates  scenario  A,   and  the  graph  labeled                                                               
"Extend  Production" illustrates  scenario B;  for this  example,                                                               
scenario B has  been producing for 16 years  and projections show                                                               
that future  production would translate  into an  operating loss,                                                               
with  the   economic  life   of  the   field  nearing   its  end.                                                               
Modification  via a  reduction  of royalty  or  net profit  share                                                               
rates could ensure that  production continues, thereby continuing                                                               
the associated revenues to the state.                                                                                           
                                                                                                                                
MR.  MEZA  used  this  graph to  answer  Representative  Hopkins'                                                               
earlier  question by  explaining  that there  were several  years                                                               
with net profit share payments;  however, the field would require                                                               
modification  to  the  lease  terms in  order  to  ensure  future                                                               
production.                                                                                                                     
                                                                                                                                
2:35:00 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HOPKINS  referred to  slide  10,  where Mr.  Meza                                                               
asserted  that  the developer  who  bid  the highest  net  profit                                                               
sharing  rate  would  be  awarded   the  lease  and  described  a                                                               
hypothetical situation.   He  asked whether  it's possible  for a                                                               
bidder,  committed  to  a  net  profit  sharing  rate  of  99.999                                                               
percent,  can   decide  during  development  that   the  rate  is                                                               
untenable  and modify  it to  a rate  lower than  what the  other                                                               
bidders proposed.                                                                                                               
                                                                                                                                
                                                                                                                                
MR. MEZA explained  that there are several  stages in development                                                               
including  exploration   of  wells;  appraisals,   which  provide                                                               
information on volume  of the resource; and  determination of how                                                               
the  facilities  would  need  to   be  designed  to  produce  the                                                               
resource.   This means  actual production  of the  resource could                                                               
begin 10  to 20 years  after the lease is  awarded.  The  rate in                                                               
the initial  bid may be  economically unfeasible by the  time the                                                               
field is fully developed.                                                                                                       
                                                                                                                                
REPRESENTATIVE HOPKINS  surmised that it  would take a  decade or                                                               
more for a developer to realize that its bid is not profitable.                                                                 
                                                                                                                                
MR. MEZA replied, "That is correct."                                                                                            
                                                                                                                                
2:38:26 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE MCKAY offered his  experience of being involved in                                                               
a project  in which the developer  intended to frack, but  due to                                                               
the geology  of the area  the plan  was impossible to  execute so                                                               
changes were made.                                                                                                              
                                                                                                                                
2:39:16 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK  asked Mr. Meza  whether there are  periodic goals                                                               
within the  life of  the lease that  need to be  met in  order to                                                               
make the lease eligible for modification.                                                                                       
                                                                                                                                
MR. MEZA explained that with the  issuance of a lease, the lessee                                                               
has  a  period  during  which   there  are  no  requirements  for                                                               
exploration  or development;  in  a few  cases  DNR will  propose                                                               
commitments,  but most  frequently activities  occur in  a manner                                                               
deemed appropriate by  the lessee.  At a  certain point, however,                                                               
the lessee must demonstrate exploitable resources.                                                                              
                                                                                                                                
2:41:39 PM                                                                                                                    
                                                                                                                                
MR.  MEZA   continued  to  slide  25,   "ELIGIBLE  SCENARIOS  FOR                                                               
MODIFICATION," which  is a continuation  from slide 24  and shows                                                               
two graphs  representing scenarios C  and D  from slide 23.   The                                                               
graph  depicting scenario  C  shows  the lease  in  year 21,  and                                                               
production  has   stopped;  without  modification  there   is  no                                                               
incentive for the lessee to  continue producing, so there will be                                                               
no more  resource extraction and  no more revenues to  the state.                                                               
The graph  depicting scenario D,  which is proposed under  HB 81,                                                               
shows  the lease  is in  year 15  and the  lessee is  considering                                                               
capital investment  in the  field, such  as drilling  outside the                                                               
boundaries  of  the  known  reservoir.   The  investment  is  not                                                               
expected to  be profitable; however,  and the  rate modifications                                                               
would  be necessary  to  incentivize the  developer  to make  the                                                               
necessary investment, thereby providing revenue to the state.                                                                   
                                                                                                                                
2:43:19 PM                                                                                                                    
                                                                                                                                
MR.  MEZA presented  slide 26,  "DECISION-MAKING PROCESS,"  which                                                               
read as follows [original punctuation provided]:                                                                                
                                                                                                                                
     A.  HB81 does  not propose  to change  the modification                                                                    
     process.                                                                                                                   
                                                                                                                                
     B. A producer applying  for a royalty modification must                                                                    
     provide a  clear and convincing showing  that they meet                                                                    
     the statutory requirements.                                                                                                
          ?  A higher  standard of  proof than  required for                                                                    
     most other DNR applications.                                                                                               
          ?   Applicants   required  to   provide   abundant                                                                    
     evidence to justify any request for relief.                                                                                
                                                                                                                                
     C. DNR may require  (for .180(j)(1)(A)) or request (for                                                                    
     .180(j)(1)(B)(C))   that producers  pay up  to $150,000                                                                    
     per application  for consulting  work to  support DNR's                                                                    
     evaluation of the application.                                                                                             
                                                                                                                                
     D.  Publication  of  Best Interest  Finding  and  offer                                                                    
     presentation to Legislature (AS 38.05.180(j)(9)-(10))                                                                      
                                                                                                                                
       E. If granted, modifications are not transferrable                                                                       
       without the authorization of the Commissioner. (AS                                                                       
     38.05.180(j)(5))                                                                                                           
                                                                                                                                
2:45:19 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  MCKAY   asked  for  an  estimate   for  how  much                                                               
production would increase as a result of HB 81.                                                                                 
                                                                                                                                
MR. MEZA responded  by explaining that economic  viability of the                                                               
fields is  the focus, with  estimates of future production  to be                                                               
included with the application for modification.                                                                                 
                                                                                                                                
2:46:50 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  GILLHAM asked  whether  there must  be a  minimum                                                               
production level before modifications can  be put into place.  He                                                               
referred to the  Kuparuk River Unit on slide 9  and asked whether                                                               
that lease  would have to produce  50,000 barrels a day  in order                                                               
to get  a modification, or  whether the modification would  be in                                                               
affect with the first barrel of oil.                                                                                            
                                                                                                                                
MR. MEZA replied  that HB 81 doesn't propose  requiring a certain                                                               
level of production  but that the information  would be important                                                               
when  evaluating  the  application  for  modification.    In  the                                                               
Oooguruk  unit  modification,  which  had been  approved  by  the                                                               
legislature,  the reduced  royalty rate  was in  effect with  the                                                               
first barrel  because the pool  hadn't been  producing previously                                                               
and  had a  "defined expiration  mechanism" that  would gradually                                                               
return royalty rates to the original level.                                                                                     
                                                                                                                                
2:48:54 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK  referenced slide  26 and noted  that HB  81 isn't                                                               
proposing changing the process for  royalty rate adjustments, and                                                               
he  asked Mr.  Meza to  clarify whether  HB 81  requires the  DNR                                                               
commissioner  to follow  the same  process for  net profit  share                                                               
rate modifications as it does for royalty modifications.                                                                        
                                                                                                                                
MR.  MESA  confirmed that  is  correct.    He  said HB  81  would                                                               
establish  that DNR  follow the  same process  as is  applied for                                                               
royalty modifications.                                                                                                          
                                                                                                                                
CHAIR PATKOTAK  noted that  the focus  thus far  has been  on the                                                               
North Slope and  asked whether HB 81 would  affect oil production                                                               
in the rest of the state.                                                                                                       
                                                                                                                                
MR. MESA  responded that there  are no NPSLs anywhere  other than                                                               
the North Slope.                                                                                                                
                                                                                                                                
CHAIR PATKOTAK  asked whether HB  81 would  apply to all  oil and                                                               
gas production instead of being specific to a region.                                                                           
                                                                                                                                
MR. MESA replied, "Yes, correct."                                                                                               
                                                                                                                                
2:50:39 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  SCHRAGE  stated  his assumption  that  there  are                                                               
other  factors  that  go into  a  company's  production  decision                                                               
besides the royalty and net profit share rates.                                                                                 
                                                                                                                                
MR. MESA  replied that there  are other variables such  as price,                                                               
the  cost structure  of the  project,  and the  fiscal system  in                                                               
general.   He  said that  this presentation  is showing  only the                                                               
cases  of  royalty and  net  profit  share modifications  because                                                               
those are areas "within the purview of the DNR commissioner."                                                                   
                                                                                                                                
REPRESENTATIVE  SCHRAGE  asked whether  there  is  a scenario  in                                                               
which  rate modification  could coincide  with changing  economic                                                               
conditions and  result in the  state receiving less  revenue than                                                               
it would have under the original lease agreement.                                                                               
                                                                                                                                
MR. MESA  answered that DNR  considers both current  and expected                                                               
future  price levels  over the  life of  the project,  and weighs                                                               
both  highly   optimistic  and  highly  pessimistic   cases,  and                                                               
everything in between, in modification adjustments.                                                                             
                                                                                                                                
2:53:04 PM                                                                                                                    
                                                                                                                                
CHAIR PATKOTAK said  that in future meetings  the committee would                                                               
be looking at  the process by which an NPSL  is modified and what                                                               
criteria the lessee must meet.                                                                                                  
                                                                                                                                
2:53:55 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HOPKINS said  that  he would  be  looking for  an                                                               
answer to the question of the origination of HB 81.                                                                             
                                                                                                                                
2:54:01 PM                                                                                                                    
                                                                                                                                
REPRESENTATIVE  HANNAN noted  that she  would like  to know  "how                                                               
long the idea has been brewing"  and why it hasn't been addressed                                                               
before now, especially in the face of declining production.                                                                     
[HB 81 was held over.]                                                                                                          
2:55:59 PM                                                                                                                    
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
There being no further business before the committee, the House                                                                 
Resources Standing Committee meeting was adjourned at 2:56 p.m.                                                                 

Document Name Date/Time Subjects
HB 81 Presentation to HRES 3.5.2021.pdf HRES 3/5/2021 1:00:00 PM
HRES 3/10/2021 1:00:00 PM
HRES 3/19/2021 1:00:00 PM
HB 81
HB 81 Sectional Analysis Version A 2.23.2021.pdf HRES 3/5/2021 1:00:00 PM
HRES 3/10/2021 1:00:00 PM
HRES 3/17/2021 1:00:00 PM
HRES 3/19/2021 1:00:00 PM
HB 81
HB 81 Sponsor Statement 1.28.21.pdf HRES 3/5/2021 1:00:00 PM
HRES 3/10/2021 1:00:00 PM
HRES 3/17/2021 1:00:00 PM
HRES 3/19/2021 1:00:00 PM
HB 81
HB 81 Support DNR NPSL One Pager 3.5.2021.pdf HRES 3/5/2021 1:00:00 PM
HRES 3/10/2021 1:00:00 PM
HRES 3/17/2021 1:00:00 PM
HRES 3/19/2021 1:00:00 PM
HB 81