Legislature(1995 - 1996)

04/19/1995 08:15 AM Senate FIN

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
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                             MINUTES                                           
                          JOINT MEETING                                        
               HOUSE AND SENATE FINANCE COMMITTEES                             
                         April 19, 1995                                        
                            8:15 a.m.                                          
                                                                               
  TAPES                                                                        
                                                                               
  SFC-95, #35, Side 1 (420-end)                                                
  SFC-95, #35, Side 2 (575-114)                                                
                                                                               
  CALL TO ORDER                                                                
                                                                               
  Senator Steve Frank, Co-chairman, Senate Finance  Committee,                 
  convened  the  Joint  House  and  Senate  Finance  Committee                 
  meeting at approximately 8:15 a.m.                                           
                                                                               
  PRESENT                                                                      
                                                                               
            Senators                 Representatives                           
                                                                               
            Sen. Frank               Rep. Martin                               
            Sen. Halford             Rep. Brown                                
            Sen. Donley                                                        
            Sen. Phillips                                                      
            Sen. Rieger                                                        
            Sen. Sharp                                                         
                                                                               
  Representative  Mark  Hanley,  Co-chairman,   House  Finance                 
  Committee arrived  soon after  the meeting  began.   Senator                 
  Zharoff  and  Representatives  Foster,  Grussendorf,  Kelly,                 
  Kohring, Mulder,  Navarre, Parnell, and  Therriault did  not                 
  attend.                                                                      
                                                                               
  ALSO ATTENDING:   Representative Gail  Phillips, Speaker  of                 
  the  House  of  Representatives; Wil  Condon,  Commissioner,                 
  Dept. of  Revenue;  Annalee McConnell,  Director, Office  of                 
  Management and Budget; Dr.  Charles Logsdon, Chief Petroleum                 
  Economist, Oil  and Gas  Division, Dept.  of Revenue;  Nancy                 
  Slagle,  Director,  Division  of Budget  Review,  Office  of                 
  Management and  Budget; Mike  Greany, Director,  Legislative                 
  Finance Division; and  aides to committee members  and other                 
  members of the legislature.                                                  
                                                                               
  SUMMARY INFORMATION                                                          
                                                                               
                     Spring Revenue Forecast                                   
               Presentation by Dr. Charles Logsdon                             
                      Department of Revenue                                    
                                                                               
  Upon convening the joint meeting, Senate Finance Co-chairman                 
  Steve Frank  invited Commissioner  Wil Condon,  OMB Director                 
  Annalee  McConnell,  and  Chief  Petroleum  Economist  Chuck                 
  Logsdon to join committee members at the table.                              
                                                                               
                                                                               
  WIL CONDON, Commissioner, Dept. of Revenue, advised that the                 
  department lowered its  mid-case forecast for FY  96 general                 
  fund revenue  by $184  million from  the November  forecast.                 
  The reduction is based on:                                                   
                                                                               
       1.   Present belief that North Slope production will be                 
            down 92,000 barrels a day from the fall forecast.                  
                                                                               
       2.   A  20-cent  reduction  in  the  destination  price                 
  forecast            from $16.72 to $16.52 a barrel.                          
                                                                               
       3.   Expectation   that   transportation   costs   that                 
  determine what           the state receives at  the wellhead                 
                           will  be 51  cents a  barrel higher                 
                           than in November.                                   
                                                                               
  The  Commissioner  referenced  the   department's  five-year                 
  forecast  presenting high,  medium,  and  low scenarios  and                 
  acknowledged  that  in some  years  prices and  volume would                 
  achieve the high  case.   However, the market  is likely  to                 
  decrease to  the low  level as  well.   The department  thus                 
  plans around the mid  case.  At the present time,  the price                 
  of  ANS  crude is  over  $18.50  a barrel.    The department                 
  forecast for FY 96 is $16.52.  While FY 96 may prove to be a                 
  high year, when projecting basic market fundamentals for the                 
  next few years,  the department does not foresee  a dramatic                 
  change.    Market fundamentals  call  for a  price,  in 1995                 
  terms, of $16.50 a barrel.                                                   
                                                                               
  Speaking  to   volume,  Mr.   Condon  referenced   a  recent                 
  presentation  by  Cambridge  Research.   He  noted  that the                 
  presentation  was  perceived  as   optimistic  in  terms  of                 
  production projections.  Department projections through 2002                 
  exceed those of Cambridge.                                                   
                                                                               
  ANNALEE  McCONNELL,  Director,  Office   of  Management  and                 
  Budget, next  spoke to the relationship  between projections                 
  and the upcoming FY 96 budget.   She referenced the lowering                 
  of  the expected  oil  price  between  the fall  and  spring                 
  revenue forecast and stressed need for a "much firmer fiscal                 
  plan  for the state."  She cautioned that in getting to that                 
  point it  does not  make sense  to take  hasty action  which                 
  could  have a negative impact on  the overall state economy.                 
  However, the  administration will  be more  closely tracking                 
  what occurs on a month-by-month basis.  There is opportunity                 
  for mid-year course correction, if necessary.                                
                                                                               
  Mrs. McConnell stressed need to work closely with the  long-                 
  range  fiscal  planning  commission.    She  reiterated  her                 
  caution  against  action that  could  drive state  and local                 
  economies downward.   The administration  believes it is  on                 
  track in terms of  bringing the budget down from  the amount                 
  originally  proposed in February.  It would not, however, be                 
                                                                               
                                                                               
  prudent to take drastic action.                                              
                                                                               
  CHUCK LOGSDON, Chief Petroleum  Economist, Dept. of Revenue,                 
  next  spoke to  members.  Directing  attention to  a handout                 
  (copy  appended  to  these  minutes),  Mr. Logsdon  noted  a                 
  projection of $1.885  billion for FY 95.  Due  to higher oil                 
  prices, the department will attempt to update that number by                 
  May 1.  Mr. Logsdon estimated  that revenues would amount to                 
  approximately $1.9 billion, if oil prices remain high.                       
                                                                               
  Figures for FY  96 evidence the largest  adjustment from the                 
  fall forecast.  The  projection is $1.775 billion for  FY 96                 
  and $1.828  billion for  FY 97.   The  department is  fairly                 
  confident  that,  in nominal  dollar  terms, the  state "can                 
  probably bring in something around  $1.9 billion a year," if                 
  production and price remain close to the mid-case level.                     
                                                                               
  Referencing  the  second page  of  the handout,  Mr. Logsdon                 
  explained  that if the forecast  were to be characterized by                 
  one assumption, it would be production.  The department made                 
  a  "fairly   radical  adjustment  downward"   in  production                 
  estimates in the  short term.   For the last several  years,                 
  the  department held with  a "fairly  optimistic" projection                 
  from Prudhoe Bay in FY 95 and 96.  The department  felt that                 
  with commissioning of  the GHX2 project, decline  at Prudhoe                 
  Bay could  be  mitigated  to  a significant  degree.    More                 
  experience as the project progresses  indicates that not all                 
  of  the  oil  originally  anticipated   will  be  recovered.                 
  Changes in  production numbers  reflect a one-time  downward                 
  adjustment  compounded  by  weather-related  down  time  and                 
  unplanned seasonal maintenance on the Prudhoe Bay oil field.                 
  The  foregoing  resulted  in  a  92,000  barrel  decline  in                 
  production  estimates  for  the North  Slope  from  the fall                 
  forecast.  That is the bad news.                                             
                                                                               
  The good news is  that there is much additional  activity on                 
  the slope.  An  aggressive plan would expand Milne  Point up                 
  to  approximately  50,000  barrels  a   day.    Milne  Point                 
  facilities will thus be moving  oil to market at  "something                 
  closer to what the original plans suggested they would  be."                 
  That  will  be   achieved  because  of  discovery   of  new,                 
  producible   pay  made   possible  through   technology  and                 
  additional  exploration.      A  large  scale  enhanced  oil                 
  recovery  (LSEOR)  project  will  move  natural gas  liquids                 
  through  the  pipeline  and  enhance  recovery  at  Kuparuk.                 
  Commencement of additional well drilling at both Kuparuk and                 
  Prudhoe Bay will  extend production further into  the future                 
  than earlier anticipated.                                                    
                                                                               
  End:      SFC-95, #35, Side 1                                                
  Begin:    SFC-95, #35, Side 2                                                
                                                                               
  The  decline  rate for  the North  Slope  now appears  to be                 
  closer to 4%.   When  the production curve  is matched  with                 
                                                                               
                                                                               
  that  for  revenue, it  evidences  a downturn  for  the next                 
  several years but  subsequent upward movement over  the next                 
  five or six  years to around $1.9 billion  a year in general                 
  fund unrestricted moneys.                                                    
                                                                               
  Adjustments in production  numbers highlight changes  in the                 
  tax  rate.   Mr.  Logsdon noted  that  the severance  tax is                 
  subject to the  economic limit factor  (ELF).  The ELF  is a                 
  direct  function of the  number of barrels  produced and the                 
  number of wells that produce them.   If the number of  wells                 
  remains  the  same or  increases,  and production  drops, on                 
  average that lowers  the amount  of oil coming  out of  each                 
  well.  That is exactly what lowers  the ELF.  Page 3 of  the                 
  handout reflects the fact that the  tax rate is beginning to                 
  come down.   It "takes a  fairly good sized  drop between 95                 
  and  96."  Also of importance is  the fact that Pt. McIntyre                 
  is  "incredibly   productive"  and  is   paying  substantial                 
  severance tax.  It is producing upwards of 140,000 barrels a                 
  day out of  wells producing  7,000 to 8,000  barrels a  day.                 
  The ELF is thus close to .9, the maximum rate.                               
                                                                               
  The  forecast assumes  that in order  to keep  production at                 
  those levels,  producers may double  the number of  wells in                 
  the field.   The  resulting effect  will be  that production                 
  remains the same  but the tax drops.   Every 1% drop  in the                 
  ELF at $10 a barrel  at the wellhead costs the  state "about                 
  $7 million."   In 96, the state will  face "nearly a 5% drop                 
  in the tax rate."  That translates to $35 to $40 million.                    
                                                                               
  Referencing page  4 of  the handout,  Mr. Logsdon  explained                 
  that  the fall forecast used $16.72 as the base price for FY                 
  96.  That  was rolled  back approximately 20  cents for  the                 
  spring forecast because  of a serious  push by Iraq to  have                 
  the embargo lifted.   The United  Nations declined to do  so                 
  with the  exception of a  limited sale of  up to  $2 billion                 
  worth of oil  to fund war  reparations and provide food  and                 
  medicine which the  United Nations  would distribute to  the                 
  Iraqi people.  That arrangement was unacceptable to Iraq.                    
                                                                               
  The world  view presented  by Cambridge  is consistent  with                 
  that of the Dept. of Revenue.  On the demand  side, economic                 
  growth is expected to be relatively robust for the next five                 
  years, with the exception of Japan.   The global increase in                 
  oil consumption is  approximately 2  million barrels a  day.                 
  Of that,  OPEC  picked  up  less  than  half,  and  non-OPEC                 
  benefited from the greater share.                                            
                                                                               
  Speaking  to  supply,   Mr.  Logsdon  noted   that  non-OPEC                 
  production continues to increase, and  there are projections                 
  of another  large increase  from the  North  Sea next  fall.                 
  That is anticipated to exert downward pressure on price, and                 
  it is  showing "up only a little  bit in the futures market"                 
  where contract prices for next fall  are "just a few pennies                 
  lower than the cash price today."                                            
                                                                               
                                                                               
  The key issue for OPEC is  Iraq and its 3 million barrels  a                 
  day  which   have  been   sitting  on   the  sidelines   for                 
  approximately five years.  Although most feel this oil  will                 
  not reenter the market while Saddam Hussein is president, it                 
  remains a cause for concern.                                                 
  The real area of potential growth continues to be the former                 
  Soviet Union, countries in the Middle East, and areas around                 
  the   Caspian  and  Black  Seas.    The  chief  obstacle  to                 
  development is getting the oil to market.  In the long term,                 
  this represents a  huge amount of  oil that could enter  the                 
  market.                                                                      
                                                                               
  Mr. Logsdon  cautioned that in not producing and selling its                 
  3 million barrels a day,  Iraq is banking 90 to  100 billion                 
  barrels in reserves.   Those  barrels will  be available  at                 
  some time in the future.                                                     
                                                                               
  When  evaluating all of the  foregoing, the Dept. of Revenue                 
  projects a  tendency for  mid-scenario oil  in the  $16.50 a                 
  barrel  range.  It  further assumes that  the mid-case price                 
  will keep pace with inflation.  It is further projected that                 
  the price  will be  close to  $16.50  per barrel  purchasing                 
  power in the year 2005.                                                      
                                                                               
  Mr. Logsdon explained  that for planning purposes,  some oil                 
  companies focus  on the  low scenario, $15.00  oil.   Market                 
  dynamics that move  the price in  that direction may  always                 
  occur.  He cautioned against reliance on the high projection                 
  of $18.00 and noted that an $18.00 year may be followed by a                 
  $13.97 year.   Due to that volatility,  a long-term planning                 
  price of $16.50 is more prudent.                                             
                                                                               
  Speaking   to  pricing,   Mr.  Logsdon  noted   that  Alaska                 
  experiences  "some  fairly big  deductions  from  that sales                 
  price" in determining  the wellhead  value upon which  taxes                 
  and  royalties  are based.    He  next  referenced  a  graph                 
  entitled, "Transportation  Costs to Lower 48"  and explained                 
  that it  rolls  together both  the  TAPS charge  and  tanker                 
  costs.  FY 95  reflected a "big jump" in the  cost of moving                 
  ANS to market.   The  largest share resulted  from the  1995                 
  TAPS  filing  evidencing  unanticipated operating  expenses.                 
  Hundreds of millions of dollars were expended by Alyeska for                 
  electrical work,  corrosion repair,  etc.   That caused  the                 
  tariff to be 50 cents higher than  anticipated.  Most of the                 
  20  to 30-cent  increase  in marine  transportation reflects                 
  "increased . . . 90-type regulatory costs."  These costs are                 
  allowed deductions against the severance tax.                                
                                                                               
  Mr. Logsdon referenced the next graph and noted decreases in                 
  tanker  and  pipeline costs  between  1995  and 1998.    The                 
  decrease  for  marine  transportation  indicates that  fewer                 
  barrels of ANS  will be transported  to the gulf coast,  and                 
  average  transportation  costs  will thus  drop.    Further,                 
                                                                               
                                                                               
  depreciation on capital pipeline costs has declined but will                 
  again increase beyond  the year  2000 as additional  capital                 
  investments  are needed.   Projected  declines in  operating                 
  costs reflect  a reduction in the number  of barrels shipped                 
  through the  pipeline.  Decommissioning of  facilities (pump                 
  stations) will  also lower fixed  costs.  The  department is                 
  projecting transportation costs of below $4.50 a barrel over                 
  the next five to six years.                                                  
                                                                               
  Mr. Logsdon  next directed  attention to  the "Alaska  State                 
  Revenue Matrix" and  pointed to projected revenue  of $1,948                 
  million based on a  price of $18.00 and FY 96  production of                 
  1.50 million  barrels.   That number  is approximately  $200                 
  million higher than the current base case.                                   
                                                                               
  Responding to a question from Co-chairman Halford concerning                 
  the high and low range of  production for FY 96, Mr. Logsdon                 
  advised  of a single  point estimate for  production for the                 
  short term.   The Co-chairman  voiced concern that  although                 
  production  was  a "big  component  of  the last  error"  no                 
  potential  range  is  shown.    Mr.  Logsdon  concurred  and                 
  explained that that  is one of  the reasons the  sensitivity                 
  matrix was developed.                                                        
                                                                               
  Representative Martin voiced his belief  that, at this time,                 
  Alaska's welfare  depends more  upon production  than price.                 
  He then  asked  if  it  is  possible  to  obtain  additional                 
  information from producers  and suggested  need for a  five-                 
  year production average.  Commissioner Condon explained that                 
  the   individual   responsible   for  production   estimates                 
  carefully reviews development  plans submitted by  operators                 
  and reviews  production forecasts with  pertinent companies.                 
  That results in "the best we can do" in terms of discussions                 
  with those responsible  for investment of capital  moneys in                 
  an attempt to "get the hydrocarbons out of the ground."                      
                                                                               
  In  response  to  a  further  question  from  Representative                 
  Martin,  Commissioner Condon  explained that  wells are  not                 
  being shut down  because they are not  producing profitably.                 
  They are being shut down because, in  the mix of oil and gas                 
  production, it  is not  optimum to  produce from  particular                 
  wells because of  the high amount  of gas produced with  the                 
  oil.  Facilities  at Prudhoe Bay  can handle only a  certain                 
  amount of  gas.   As the  field matures,  the amount  of gas                 
  produced per barrel of  oil increases daily.  The  amount of                 
  oil produced is a function of ability to handle the gas that                 
  comes out of the ground with the oil.                                        
                                                                               
  Representative Martin  asked if the state would  sustain a 3                 
  to   4%   production  loss   per   year  into   the  future.                 
  Commissioner Condon  acknowledged there would  be production                 
  loss each year.   Responding to  further questions from  the                 
  Representative, the Commissioner stressed need to anticipate                 
  the range  between  the low  and  high-case scenario.    The                 
                                                                               
                                                                               
  budget should be planned based on selection of the right mid                 
  case over the longer term.                                                   
                                                                               
  Senator  Rieger  referenced  potential  for  development  of                 
  Badami and the  String of  Peals fields.   He then  inquired                 
  concerning components of the department forecast that result                 
  in a future (1998-99) 300,000  to 400,000 barrel discrepancy                 
  when compared to Cambridge numbers.  Mr. Logsdon  voiced his                 
  belief that  the two  projections are  "pretty close  . .  .                 
  through  2002."   Beyond  that,  Cambridge speaks  to liquid                 
  production capacity.   The department  has not been  able to                 
  develop definitive  numbers  for that.   He  added that  the                 
  department  has  not  "explicitly  included production  from                 
  Badami."  The  department opted not to do  so because it has                 
  not been well delineated.  Information over the next several                 
  months should better define the number of barrels that might                 
  be  available.    Other production  mentioned  by  Cambridge                 
  remains  a  mystery.    The  department  has  not  estimated                 
  production from Hammerhead  and other  wells that have  been                 
  drilled.   The state  forecast includes  ability to  produce                 
  from North Star,  Seal Island, and  West Sak.  Those  fields                 
  are  not now  in production because  of large  cost hurdles.                 
  Technological advancements  may  make them  producible at  a                 
  reduced  cost.    Alaska  does   not  have,  in  either  its                 
  reservoirs  or  known  discoveries,  sufficient  barrels  to                 
  justify Cambridge production numbers.                                        
                                                                               
  Commissioner  Condon  clarified   that  through  2002,   the                 
  department's  forecast  is  higher   than  Cambridge.     He                 
  reiterated  that the department  projection does not include                 
  production from Badami.  The Cambridge projection does.   At                 
  2002, Cambridge "picks up  two chunks."  They include  known                 
  fields for which no development plans have been announced as                 
  well as new  discoveries which have  not occurred.  That  is                 
  where  volumes within the two projections  diverge.  At that                 
  point the Dept. of Revenue estimate begins to decline, while                 
  the Cambridge estimate increases.  For producing fields, the                 
  department's  projection is  more  optimistic  than that  of                 
  Cambridge.                                                                   
                                                                               
  House  Speaker  Gail   Phillips  asked  if   the  department                 
  requested  detailed  information   on  future  numbers  from                 
  Cambridge.   Mr. Logsdon  said the  department received  the                 
  actual  numbers  but  not    requested   backup  information                 
  underlying the numbers.                                                      
                                                                               
  Discussion followed  between Senator  Sharp and  Mr. Logsdon                 
  reiterating earlier comments  regarding increased  operating                 
  costs that gave rise  to the tariff increase  in 1995.   Mr.                 
  Logsdon explained that the state does not absorb "the entire                 
  blow."  The state pays 25 cents for every dollar increase in                 
  cost through lower  wellhead value  and lower severance  tax                 
  and  royalties.    The  $300  to  $400  million increase  in                 
  unanticipated  operating expenditures  relates  to the  fact                 
                                                                               
                                                                               
  that  the  pipeline   is  getting  old.    Repairs  must  be                 
  undertaken to keep the system in tact.                                       
                                                                               
  Senator  Rieger  advised   of  information  from   Cambridge                 
  indicating that future  reserves relate to three  areas with                 
  estimated reserves of 150 to 300 million barrels.                            
                                                                               
  ADJOURNMENT                                                                  
                                                                               
  The meeting was adjourned at approximately 9:05 a.m.                         
                                                                               

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