Legislature(2007 - 2008)SENATE FINANCE 532
02/04/2008 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| SJR14 | |
| SB242 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SJR 14 | TELECONFERENCED | |
| += | SB 242 | TELECONFERENCED | |
| + | TELECONFERENCED |
SENATE FINANCE COMMITTEE
February 4, 2008
9:10 a.m.
CALL TO ORDER
Co-Chair Stedman called the Senate Finance Committee meeting
to order at 9:10:14 AM.
MEMBERS PRESENT
Senator Lyman Hoffman, Co-Chair
Senator Bert Stedman, Co-Chair
Senator Charlie Huggins, Vice-Chair
Senator Kim Elton
Senator Donny Olson
Senator Joe Thomas
Senator Fred Dyson
MEMBERS ABSENT
None
ALSO PRESENT
Fred Triem, Petersburg; Kevin Mitchell, Vice President,
Finance and Administration, ConocoPhillips, Alaska; Marilyn
Crockett, Executive Director, Alaska Oil and Gas Association
(AOGA)
PRESENT VIA TELECONFERENCE
None
SUMMARY
SJR 14 Proposing an amendment to the Constitution of the
State of Alaska relating to appropriations from
the budget reserve fund.
CSSJR 14 (FIN) was reported out of Committee with
a "no recommendation" and with a new fiscal note
by the Office of the Governor.
SB 242 "An Act relating to lease expenditures that may be
deducted for purposes of the production tax on oil
and gas; relating to the retroactivity provisions
of changes to the production tax on oil and gas
enacted in ch. 1, SSSLA 2007; and providing for an
effective date.
SB 242 was heard and HELD in Committee for further
consideration.
9:11:44 AM
SENATE JOINT RESOLUTION NO. 14
Proposing an amendment to the Constitution of the State
of Alaska relating to appropriations from the budget
reserve fund.
No one from the public was present to testify on SJR 14.
SJR 14 was set aside for the moment.
9:12:30 AM
SENATE BILL NO. 242
"An Act relating to lease expenditures that may be
deducted for purposes of the production tax on oil and
gas; relating to the retroactivity provisions of
changes to the production tax on oil and gas enacted in
ch. 1, SSSLA 2007; and providing for an effective
date."
Senator Elton MOVED to ADOPT Amendment 1, labeled 25-
LS1350\A.1, Bullock, 1/29/08.
Co-Chair Stedman OBJECTED for discussion purposes.
Co-Chair Stedman reported that the amendment was a technical
change. After HB 2001 was enrolled, some sections were
renumbered; SB 242 conforms to those changes.
There being NO OBJECTION, Amendment 1 was adopted.
9:14:39 AM
FRED TRIEM, PETERSBURG, testified against the retroactive
component of the bill. He related that his opposition is
based on historical reasons. He shared a story about
taxation during the early colonial days when the Crown
imposed unfair and vexatious taxes. When the Declaration of
Independence was written in 1787, a clause was included
regarding enacting retroactive laws. He suggested having a
prospective tax at a higher tax rate. He concluded that the
Alaska legislature should not enact retroactive laws.
9:23:35 AM
Senator Thomas asked Mr. Triem if he would feel the same
about a rebate. Mr. Triem thought that would not be a
retroactive tax. He described his opposition to retroactive
taxation. Senator Thomas pointed out that the bill was a
compilation of many opinions and was in response to a tax
rate that some felt was not right. He thanked the testifier
for his comments.
9:25:11 AM
Senator Huggins thought that many Alaskans felt the same as
Mr. Triem. He reminded the committee that HB 2001 had an
effective date of January 1, 2008.
9:26:54 AM
KEVIN MITCHELL, CONOCOPHILLIPS, VICE PRESIDENT, FINANCE AND
ADMINISTRATION, ALASKA, pointed out that there are two
components to the bill, the removal of the standard
operating cost deduction at Prudhoe Bay and Kuparuk, and the
removal of the retroactive implementation of the bill.
Mr. Mitchell addressed retroactivity first. He said that
the decision to retroactively apply tax increases is a
policy call of the legislature. It is a question of
fairness to those taxpayers. Retroactive tax increases send
a very clear message to investors. It's a message that the
Alaskan fiscal environment is an uncertain one. He
maintained that investment decisions need to be taken with
care. Retroactive tax increases are bad tax policy. The
response by investors is to take a cautious approach,
especially with regard to longer-term investments. Long-
term investments face more fiscal uncertainty by their
nature. A track record of retroactive tax increases adds
further to that uncertainty. He gave an example of property
taxes made retroactive, as a bad idea. He testified in
support of SB 242 because it corrects a wrong.
Mr. Mitchell addressed standard deduction for operating
costs at Kuparuk and Prudhoe Bay. The standard deduction is
a tax targeted on Prudhoe and Kuparuk, which is unfair and
creates uncertainty for investors who cannot assume that all
investments and all taxpayers will be treated alike. He
opined that the current tax policy is not fair to those old
fields with increasing need for maintenance activity. He
maintained that the tax law encourages producers to reduce
costs since actual costs are increasing at a rate greater
than the 3 percent escalation allowed for in the current
production tax law. The increases are a function of higher
activity levels and industry cost escalation. He spoke of
great opportunities for investment and development at
Prudhoe and Kuparuk. The standard deduction does not
encourage that investment, as incremental operating costs
are not deductable. He remarked that in light of the
legislature's propensity to increase taxes, the sunset
provision of 2010 does not provide much comfort.
Mr. Mitchell spoke about unintended consequences of the
standard deduction. Almost 70 percent of operating costs
are manpower related. With the tax law that is in place
today, the industry is incentivized to reduce those costs at
Prudhoe and Kuparuk more so than ever before. Standard
deduction is also having unintended consequences on facility
sharing agreements. The cost to new producers for access to
Kuparuk and Prudhoe facilities increases significantly
because of the tax effect. Incremental costs associated
with processing and handling new production is no longer
deductible. The revenue received for facility sharing is
taxable. That increases the taxable margin per barrel which
increases the tax rate that's applied to all production for
those facility owners. That additional cost is passed on to
the new producer seeking access to those facilities.
Mr. Mitchell concluded that ConocoPhillips supports the
removal of the standard operating cost deduction from the
production tax law.
9:33:08 AM
Co-Chair Stedman asked about the 3 percent deduction
modeling presented by Mr. Dickinson previously. Mr.
Mitchell responded that he had not looked at that in detail.
He reported that from 2005 - 2006, ConocoPhillips' operating
costs increased by around 45 percent. From 2006 - 2007 it
was not a similar high level of increase, yet still higher
than at a 3 percent rate. Without the regulations in place,
it is difficult to know the base line at this time.
Co-Chair Stedman requested more information about the
"activity level". Mr. Mitchell responded that those are
maintenance and repair activity - continuing costs on old
fields. A lot of the work is not discretionary and must be
done for safety's sake.
9:35:24 AM
Co-Chair Stedman asked for comment on the marginal tax rate
at $90 per barrel and who benefits from it. Mr. Mitchell
replied that the marginal rates differ depending on whether
one is talking about an increase in price or volume, or a
change in costs. In general, at current price levels the
marginal government take is around 80-85 percent. Some of
that is driven by the effect of progressivity. The marginal
take for an additional dollar per barrel of revenue ends up
being somewhere in excess of 80 percent.
9:37:33 AM
Co-Chair Stedman suggested framing that answer in layman
terms. He gave an example of revenue generated from
additional production using 80 percent for marginal
government take; the industry would get 20 cents, the
federal government and the state would get 80 cents - the
federal portion of that would be roughly a marginal
corporate tax rate of 34 percent, so that the state number
would be in the high 40's. He concluded that for each
marginal barrel not produced, the state treasury is the
biggest loser as far as net incremental dollars. Mr.
Mitchell agreed, but thought the state share would be even
larger because the production tax is deductible against
federal tax. That would reduce the federal piece at the
expense of the state. Co-Chair Stedman emphasized that it
is in the state's best interest to target marginal
production.
9:39:28 AM
Co-Chair Stedman noted concern with the standard deduction
because it does not encourage marginal production. He
reported hearing conflicting information about how the 3
percent cap on operating expenditures affects Prudhoe Bay
and Kuparuk, especially regarding new entrants or
independents.
Co-Chair Stedman asked about the 3-year time horizon. He
thought it could as easily be extended as terminated. He
asked Mr. Mitchell to ask ConocoPhillips' economist about
cost escalation in operating and capital expense around the
world. In retrospect, both the Administration and the
legislature should have paid more attention. He also
requested current thoughts on operating and capital cost
appreciation globally, and for price appreciation
information for 2007 and 2008.
9:43:01 AM
Senator Thomas pointed out that Mr. Mitchell drew attention
to the relationship between operating cost and capital
expenditure, because the more capital one invests, the more
facilities are being built or expanded. The increased
operating expense tax would have a detrimental affect on
expansion and exploration. Mr. Mitchell agreed that
additional capital investments usually bring additional
capital costs. Senator Thomas asked if oil industry taxes
around the world are decreasing. Mr. Mitchell replied that
taxes are going up. Senator Thomas asked if profits are
going up. Mr. Mitchell replied that income reported by
ConocoPhillips in Alaska in 2007 was lower than in 2006,
despite a higher price environment. Profits decreased
primarily due to taxes.
9:44:59 AM
Senator Huggins addressed unintended consequences of the
standard deduction, which were not known at the time that
AGIA passed. He requested information about solutions for
unintended consequences. Mr. Mitchell replied that there
have not been any conversations on that subject between the
Administration and the producers. Senator Huggins
emphasized that the legislature needs to push for a
resolution to the problem.
9:47:17 AM
Senator Dyson requested that the Administration participate
in the conversation about unintended consequences.
Co-Chair Stedman agreed. He stressed that the marginal tax
issue also needed to be addressed. Senator Dyson also
wanted input from the Administration about the zero fiscal
note, which he thought did not make sense. He thought the
fiscal note should reflect the consequences if the bill
passes. He recalled reluctance to reopen the discussion on
HB 2001.
Co-Chair Stedman reported that the fiscal note from the
Department of Revenue was for about $800 million, not zero.
He agreed to find out more about the impact to the treasury.
9:50:26 AM
Senator Thomas asked if the standard deduction was an
onerous provision to the industry. Mr. Mitchell talked
about how the tax bill was based on a net tax structure and
not a gross tax structure. The standard deduction removes
some aspects of the true net tax and it becomes more like a
modified gross tax.
Co-Chair Stedman reported that it costs about $25 per barrel
to get the oil out of the ground and shipped out. With
market value at $75, there is a $50 profit. The marginal
tax would be around 80 percent. He countered that it shifts
more toward gross, rather than pushing the marginal tax rate
up. Mr. Mitchell agreed. He explained that the standard
deduction, to the extent that actual costs are higher than
the cap on operating costs, becomes another tax increase
over and above the increase in progressivity and other
factors.
9:53:38 AM
MARILYN CROCKETT, EXECUTIVE DIRECTOR, ALASKA OIL AND GAS
ASSOCIATION (AOGA), read from a written statement:
AOGA is a trade association for the oil and gas
industry in Alaska. Our 16 members account for the
majority of oil and gas exploration, development,
production, transportation, refining and marketing
activities in the state. My testimony today reflects
the full consensus of the members of AOGA, with no
dissent.
It is no secret that AOGA opposed the provisions
addressed in this bill during the 2007 Special
Legislative Session. And it should come as no surprise,
of course, that we do support the repeal of these
provisions now. In fact, just in the first three months
since the passage of ACES, we have already seen some
companies announce reductions in their investment
plans. Unfortunately, this is a trend we expect will
continue.
In considering the merits of SB 242, it's important to
take into account how it will impact the real-world
situation that Alaska faces. The greatest challenge
that confronts this generation of Alaskans and the next
is the ongoing decline of oil production, which has
been, is today, and promises to remain the cornerstone
of the finances of state government.
Production decline is eroding this cornerstone. Even
with the massive investments made in the past, North
Slope production declined an average of 6.2% a year
from FY 1997 to FY 2007, and Cook Inlet oil production
declined at 8.0% a year. Without those investments,
decline would have been approximately 15%.
There are three categories of investment that can slow
the rate of decline on the North Slope, or at least
keep it from getting any worse. These are, first,
investment in exploration to discover new fields;
second, investment in existing fields to prevent their
decline from accelerating; and third, investment in
innovation, technology, and new
infrastructure to allow development of the vast but
challenging resource of heavy and viscous oil that has
already been discovered.
To be sure, exploration plays an important role in
Alaska production. But even when exploration succeeds
in discovering a commercially viable field, it will
take years from the time of its discovery until the
time production from it begins. But the challenge of
declining production confronts Alaska today - not
eight, ten or a dozen years from now. By its nature,
investing in exploration can make a significant
contribution toward solving the challenge of declining
production in the longer term, but not the shorter term
when results are urgently needed.
Investment in heavy and viscous oil development is also
a solution in the mid to long term. The first well ever
drilled to test production from the Ugnu Formation was
only drilled in 2007 in the Milne Point Unit, and it is
still being tested and evaluated to gain a better
understanding of the physical characteristics of the
Ugnu oil. There are plans to use the results of these
tests and evaluations to plan and develop a pilot
project for producing Ugnu oil. Until then, West Sak
will continue to be the only commercial heavy/viscous
opportunity.
This gets us to investment in currently producing
fields. Fortunately, there are investments that can be
made, and are being made, in these fields to slow their
decline. In the short term, this is in-fill drilling -
that is, drilling new wells into the portions of a
reservoir that are between the wells that have already
been drilled. This accelerates the drainage of oil from
the rock that currently lies in between existing wells.
In-fill drilling last year contributed some 70,000
barrels a day to production from the Prudhoe Bay field.
To put this into perspective, a 70,000 barrel per day
th
field would be the 4 largest stand-alone field on the
North Slope today.
There are also major investments being made, and yet to
be made, in "renewal" of the surface facilities for
existing fields. For instance, the gathering centers
and flow stations for the Prudhoe Bay field have been
in service for over 30 years now. If Prudhoe Bay and
the other producing fields are to continue producing in
the decades to come, their original production
facilities will need to be overhauled or replaced.
Also, as increasing amounts of heavy and viscous oil
come into production, even relatively new facilities
that were designed for comparatively light
"conventional" oil will probably need to be modified,
refitted or replaced in order to minimize operating
problems in handling that heavy/viscous oil. Regardless
of the stimulus or purpose for making them, renewal
investments in production infrastructure present a very
similar cash-flow pattern as there is for investments
in the original infrastructure to develop a field. And
consequently, tax policy affecting the initial
development infrastructure equally affects renewal as
well. Let's first examine repeal of the standard
deduction, embodied in AS 43.55.165(k) and (l).
According to the Department of Revenue's Fall 2007
Revenue Forecast, 64-68% of future production will come
from the Prudhoe Bay and Kuparuk fields and their
satellites - the very fields which are subject to the
standard deduction limitation. This production is
absolutely critical to the state and, if anything, we
should be doing all we can to ensure aggressive efforts
are undertaken to stem the decline from these fields.
Unfortunately, limiting the deductibility of expenses
incurred to carry out these functions does nothing to
encourage this needed investment.
DOR is reportedly forecasting a relatively small gap
between 2006 costs and costs for future years. We
maintain that the recent acceleration in the cost of
doing business in the oil patch doesn't support the
notion that costs will increase only modestly in the
near-term. Indeed, worldwide, industry analysts
continue to project steadily increasing costs. Further,
just last week, one north slope operator projected the
cost of operations in the Prudhoe Bay and Kuparuk
fields at $450 million dollars over the amount for the
standard deduction.
Some have argued that since the standard deduction
applies only to operating expenses, capital
expenditures are not affected. The reality is that the
fiscal impact of anticipated operating costs is a
critical component of decision-making when it comes to
capital expenditures. As individuals we consider this
anytime we make a purchase-whether it be a vehicle or
an appliance. As legislators consider capital budgets,
a keen eye is focused on what the operational impact of
that capital expenditure will be.
So long as the standard deduction is in place,
decisions on capital expenditures in these fields will
be impacted. Further, given the hundreds of millions of
dollars at stake, little comfort can be taken in the
2009 review of this provision. Prudent decision-making
today must be conservative and cannot be based on the
"chance" that the standard deduction will be eliminated
during the 2009 review.
Turning now to retroactivity, let's look at the history
of implementation of retroactive taxing provisions.
When enacting the original Petroleum Production Tax
(PPT) the Legislature increased the tax by over $800
million during the last nine months of 2006 alone by
applying it retroactively back to April first of that
year. Then, during the last Special Legislative Session
this past fall, again, the Legislature made the
additional tax changes retroactive.
In two short years, the industry has been subjected not
only to significant changes in its tax structure, but
changes which have been applied retroactively. We are
not aware of any other oil producing region which has
retroactively applied changes to its tax regime.
Not only is this bad tax policy, it sends a dire
warning to current and new investors, who have no
assurances that the government tax regime in place as
they make investment decisions will remain in place
and, if changes are pursued, that those changes won't
be made retroactive after they've made important
investment decisions.
In addition to the impact on investment decisions,
there are very real, practical impacts dealing with
retroactivity with which the State and industry are
currently grappling.
Under the current ACES law, retroactive calculations of
tax are required and it is not clear how many aspects
of the calculation should be applied. Specifically, the
tax is a yearly tax and as such the statutory rate
change from 22.5% to 25% creates complexity and
uncertainty about how this should be calculated. We
have asked, but not yet received clarification about
what the tax rate is for 2007. The mechanics of the
calculation simply do not allow you to apply one
percentage the first half of the year and another
percentage for the second half of the year since the
tax is calculated for the full year against 100% of a
producer's production, sales, and expenditures.
Additionally, the new law only allows 50% of the 20%
capital credit to be used in the first year. So, in
2007 this applies to only half the year. The
retroactivity requirement makes it difficult to apply
this provision of the law. During the first half of the
year you should be able to receive and use 100% of the
credits earned. But the question then becomes how to
calculate how much can be used during the second half
of the year, since this is a yearly tax and credits are
earned for the year.
These issues have come up repeatedly during the
workshops being held by the Department of Revenue over
the past two months on development of its implementing
regulations but the Department has not identified a
solution to clarify a way forward and comply with the
law as enacted.
In conclusion, SB 242 provides an opportunity to ensure
that the majority of new production needed to stem the
decline of Alaska production in the short-term comes to
fruition. We encourage the Committee to move this
legislation. Thank you.
10:04:15 AM
Co-Chair Stedman requested information concerning the cost
of $400 million that was presented in Anchorage.
Senator Thomas wondered how it is known whether a reduction
in investment is due to the tax change or if it is due to a
new "find" somewhere else in the world. He questioned if
the reduction in investment is verifiable. Ms. Crockett
thought that some of it was verifiable. She gave an example
of a project that would not work due to the tax change, and
others where it would not be known.
Senator Thomas agreed that it is difficult to verify such
projects. Ms. Crockett responded that expenditures in older
fields are known.
10:09:34 AM
Senator Elton thought that even if some decisions had been
made to not invest, those decisions could be business
decisions. He summarized that there is an $800 million
impact on the retroactivity and a $450 million difference
between the standard deduction and what actually occurs, for
a net effect of $1.2 billion. One of the ways to encourage
passage of this bill would be to cancel investment in order
to save $1.2 billion. Ms. Crockett talked about how
investment decisions are made. She reiterated that the 3
percent and the retroactivity provisions are the factors
which would drive the investment decisions.
Co-Chair Stedman reported that the state forecast for FY 08
is for 730,000 barrels of oil a day, at $72.60 per barrel,
which equals $19.4 billion in gross revenue. If oil was at
$90 per barrel, there would be $24 billion in gross revenue.
It costs $25 to get oil out of the ground and to market. He
summarized that some concerns such as termination of
projects and postponement of projects would be addressed at
future meetings. He reported that he had trouble connecting
the "no impact on capital costs of the 3 percent operating
cap" and the goal to slow the decline of oil production. He
hoped to get clarification through these discussions.
10:14:34 AM
Senator Huggins requested more information about unintended
consequences for small explorers and developers. Ms.
Crockett spoke about the facility access issue. She sensed
that the Administration has been talking to the producers
and to the smaller independent companies to see if there is
a way to address this without having to legislate it. She
thought that no one intended that an independent company
bringing a new field on line was going to have to pay an
extreme premium in order to access the facilities. She did
not believe there was an attempt to limit the deductibility
of the companies that own the facilities.
10:16:52 AM
Senator Huggins spoke of the rational behind the bill. He
maintained that it was not about money, but rather about
poor techniques used to set public policy. He recalled the
special session debates about removing the "taint of PPT",
which he supported. He noted the lack of debate about
standard deduction. He maintained that the public process
was circumnavigated. The Administration did not oppose the
issue, though they did not claim to know the consequences of
standard deductions. The sunset provision anchored some
votes. Senator Huggins maintained that this bill is about
"doing the right thing" on behalf of Alaskans. He showed a
photo depicting the Cadet Honor Code at West Point. He
concluded that the honor code should be followed as it
applies to this situation.
SB 242 was heard and HELD in Committee for further
consideration.
AT-EASE: 10:23:06 AM
RESUME: 10:23:38 AM
SENATE JOINT RESOLUTION NO. 14
Proposing an amendment to the Constitution of the State
of Alaska relating to appropriations from the budget
reserve fund.
Co-Chair Stedman noted the intention to move SJR 14 forward.
10:24:46 AM
Senator Olson MOVED to REPORT SJR 14 out of Committee, as
amended, with individual recommendations and the attached
fiscal note.
CSSJR 14 (FIN) was reported out of Committee with a "no
recommendation" and a new fiscal note by the Office of the
Governor.
ADJOURNMENT
The meeting was adjourned at 10:25 AM.
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