Legislature(2011 - 2012)SENATE FINANCE 532

02/14/2012 09:00 AM Senate FINANCE


Download Mp3. <- Right click and save file as

Audio Topic
09:02:33 AM Start
09:03:22 AM Presentation by Pedro Van Meurs on Arctic and Alaska Oil Economics: Session Three
10:34:17 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Joint w/ Senate Resources TELECONFERENCED
Presentation by Pedro van Meurs on Arctic and
Alaska Oil Economics
+ Bills Previously Heard/Scheduled TELECONFERENCED
                 ALASKA STATE LEGISLATURE                                                                                       
                       JOINT MEETING                                                                                            
            SENATE RESOURCES STANDING COMMITTEE                                                                                 
                 SENATE FINANCE COMMITTEE                                                                                       
                     February 14, 2012                                                                                          
                         9:02 a.m.                                                                                              
                                                                                                                                
9:02:33 AM                                                                                                                    
                                                                                                                                
CALL TO ORDER                                                                                                                 
                                                                                                                                
Co-Chair Stedman called the Senate Finance Committee                                                                            
meeting to order at 9:02 a.m.                                                                                                   
                                                                                                                                
SENATE FINANCE COMMITTEE MEMBERS PRESENT                                                                                      
                                                                                                                                
Senator Lyman Hoffman, Co-Chair                                                                                                 
Senator Bert Stedman, Co-Chair                                                                                                  
Senator Johnny Ellis                                                                                                            
Senator Dennis Egan                                                                                                             
Senator Donny Olson                                                                                                             
Senator Joe Thomas                                                                                                              
                                                                                                                                
SENATE FINANCE COMMITTEE MEMBERS ABSENT                                                                                       
                                                                                                                                
Senator Lesil McGuire, Vice-Chair                                                                                               
                                                                                                                                
SENATE RESOURCE COMMITTEE MEMBERS PRESENT                                                                                     
                                                                                                                                
Senator Joe Paskvan, Co-Chair                                                                                                   
Senator Bill Wagoner, Co-Chair                                                                                                  
Senator Wielechowski, Vice-Chair                                                                                                
Senator Bert Stedman                                                                                                            
Senator Hollis French                                                                                                           
Senator Gary Stevens                                                                                                            
                                                                                                                                
SENATE RESOURCE COMMITTEE MEMBERS ABSENT                                                                                      
                                                                                                                                
Senator Lesil McGuire                                                                                                           
                                                                                                                                
ALSO PRESENT                                                                                                                  
                                                                                                                                
Senator Cathy Giessel; Representative Alan Austerman; Dr.                                                                       
Pedro Van Meurs, President, Van Meurs Corporation,                                                                              
Consultant                                                                                                                      
                                                                                                                                
SUMMARY                                                                                                                       
                                                                                                                                
^PRESENTATION BY  PEDRO VAN MEURS  ON ARCTIC AND  ALASKA OIL                                                                  
ECONOMICS: SESSION THREE                                                                                                      
                                                                                                                                
9:03:22 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman discussed the meeting's agenda.                                                                                
                                                                                                                                
Senator  Wagoner referenced  the  prior  day's meeting,  and                                                                    
requested  clarification  regarding  $7.5 billion  per  year                                                                    
over current  levels of investment.  He wondered  who should                                                                    
be providing that  money, the producers or  State of Alaska.                                                                    
DR.  PEDRO  VAN  MEURS, PRESIDENT,  VAN  MEURS  CORPORATION,                                                                    
CONSULTANT,  stated   that  $7.5   billion  can   be  easily                                                                    
calculated  based  on  the difference  between  the  decline                                                                    
curve and  the 1  million barrels  a day.  He said  that the                                                                    
calculation could  determine how many new  barrels needed to                                                                    
be produced.  He stated  that the new  barrels needed  to be                                                                    
derived from heavy  oil, and he determined  that the typical                                                                    
capital cost would  be approximately $30 a  barrel. Once one                                                                    
knows the total amount  of capital expenditures required for                                                                    
the  total volume  over 25  years, one  could arrive  at the                                                                    
$7.5 billion.  He stressed that  when one makes  the capital                                                                    
expenditures;  there  will  be received  tax  and  Petroleum                                                                    
Profits Tax (PPT) deductions.  Senator Wagoner surmised that                                                                    
$7.5 billion  was the  gross amount.  Mr. Van  Meurs agreed.                                                                    
Co-Chair  Stedman   stated  that  there  could   be  further                                                                    
explanation of the net amount later in the presentation.                                                                        
                                                                                                                                
9:06:33 AM                                                                                                                    
                                                                                                                                
Mr.   Van  Meurs   provided members   with  two   PowerPoint                                                                    
presentations: Policy  Options for  Alaska Oil and  Gas; and                                                                    
Addendum  2  to "Policy  Options  for  Alaska Oil  and  Gas"                                                                    
(copies on  file). He stated  that Addendum 2  would address                                                                    
some questions from the prior day's meeting.                                                                                    
                                                                                                                                
Mr.  Van  Meurs  addressed  slide  1  of  Addendum  2,  "Re-                                                                    
investment by major oil companies."  He stated that slide 13                                                                    
of the  Department of  Revenue (DOR)  presentation indicates                                                                    
that major  oil companies  reinvested $1544 million  in 2010                                                                    
in capital expenditures. Comments:                                                                                              
                                                                                                                                
   · This is about $8 per barrel produced                                                                                       
   · DOR includes capital maintenance expenditures and work                                                                     
     overs in these capital expenditures                                                                                        
   · It is likely that about $4 per barrel relates to these                                                                     
     types of expenditures. These are non-discretionary.                                                                        
     They have to be done to continue operations normally                                                                       
   · It seems that the remaining $4 per barrel is largely                                                                       
     infill drilling with the goal of accelerating cash                                                                         
     flow                                                                                                                       
  · This $4 per barrel is about $1 on an after tax basis.                                                                       
   · It is therefore clear that the three major companies                                                                       
     are "harvesting" at the maximum rate. During the last                                                                      
     5 years there was "near zero" interest in investments                                                                      
     in new projects.                                                                                                           
                                                                                                                                
Mr.  Van  Meurs felt  that  the  petroleum industry  was  in                                                                    
"harvesting mode."                                                                                                              
                                                                                                                                
Co-Chair Stedman  requested an explanation of  how one would                                                                    
receive an expenditure  impact of one dollar  when there was                                                                    
four  dollars  in  the discretionary  cost.  Mr.  Van  Meurs                                                                    
replied   that  the   four  dollars   discretionary  capital                                                                    
expenditures would  be a deduction for  corporate income tax                                                                    
and  Alaska's  Clear and  Equitable  Share  (ACES). He  also                                                                    
stated  that the  four  dollars would  be  eligible for  the                                                                    
capital expenditures tax credit, so  the one dollar would be                                                                    
the investment after taxes.                                                                                                     
                                                                                                                                
Co-Chair  Stedman  wondered  who  paid  the  leftover  three                                                                    
dollars. Mr. Van Meurs replied  that the State of Alaska and                                                                    
the federal  government would  contribute the  three dollars                                                                    
through the reduction of income.                                                                                                
                                                                                                                                
9:11:20 AM                                                                                                                    
                                                                                                                                
Senator  Stevens  wondered if  the  depletion  of oil  would                                                                    
occur  at  a faster  pace  if  there  was an  increase  from                                                                    
600,000 barrels  a day to 1  million barrels a day.  Mr. Van                                                                    
Meurs  stressed   that  the  maximum  harvesting   would  be                                                                    
referred to as the maximum  withdrawal of cash. He felt that                                                                    
the decline  rate in Prudhoe  Bay was not  abnormal compared                                                                    
to other places in the  world. He stressed that the physical                                                                    
decline rate of oil was  technical. He pointed out that when                                                                    
he  referred to  "harvesting", he  meant the  "withdrawal of                                                                    
cash."                                                                                                                          
                                                                                                                                
Senator  Wagoner  stated  that  currently,  exploration  was                                                                    
encouraged outside of the existing  units on the North Slope                                                                    
by way  of exploration credits.  He wondered if there  was a                                                                    
benefit  to  offering  production  credits.  Mr.  Van  Meurs                                                                    
stated  that production  credits  made  sense. He  furthered                                                                    
that  Alaska  was  over-encouraging exploration,  and  there                                                                    
should be a balance between production and exploration.                                                                         
                                                                                                                                
Mr. Van  Meurs discussed  slide 3  of Addendum  2, "Investor                                                                    
impact  of high  marginal rates  related to  higher prices."                                                                    
There may  be some confusion  as to the impact  on investors                                                                    
of high  marginal rates related  to higher prices.  There is                                                                    
no   direct  impact   of  marginal   rates  on   investment.                                                                    
Investments decisions  are being  made on  the basis  of the                                                                    
total  average  incremental  Net  Present  Value  (NPV)  and                                                                    
Internal Rate of Return (IRR),  not the marginal NPV or IRR.                                                                    
For  instance,  Pakistan  has in  their  production  sharing                                                                    
contracts a price  cap of $100, and over $100  of all higher                                                                    
revenues go to  the government. So the marginal  rate is 100                                                                    
percent. Yet, investments are taking  place because the take                                                                    
below $100  is relatively modest  and therefore the  NPV and                                                                    
IRR are acceptable.                                                                                                             
                                                                                                                                
9:18:11 AM                                                                                                                    
                                                                                                                                
Mr. Van  Meurs displayed  slide 4  of Addendum  2, "Investor                                                                    
impact  of high  marginal rates  related to  higher prices."                                                                    
There  are  two  important  impacts  of  very  strong  price                                                                    
progressivity:  Strong price  progressivity  means that  the                                                                    
average  rates  increase  to   higher  levels  under  higher                                                                    
prices.  In  the case of Alaska this means  that that Alaska                                                                    
will rapidly  become less attractive  than some of  the main                                                                    
competitors with  regressive systems, such as  the Lower 48,                                                                    
Australia,  Russia  and  Brazil.  New  investors  will  look                                                                    
negatively  on very  strong price  progressivity because  it                                                                    
removes   the   "upside"   of  the   possible   outcome   of                                                                    
investments.   This  is   a   strong   impediment  for   new                                                                    
investment. Even  if price progressivity is  less strong for                                                                    
new  production,  new  investors  will  still  evaluate  how                                                                    
current producers are being treated  by Alaska since this is                                                                    
an indication of the fiscal  policy of the jurisdiction. For                                                                    
these reasons  one would  not recommend  price progressivity                                                                    
that is too strong.                                                                                                             
                                                                                                                                
Co-Chair  Stedman  looked  at  slide  3,  and  requested  an                                                                    
explanation  of  other   mechanisms  used  when  determining                                                                    
progressivity. Mr.  Van Meurs replied  that there  were four                                                                    
ways to  determine progressivity:  price, which is  the tool                                                                    
Alaska  used;  profits; and  costs,  which  is a  tool  that                                                                    
Norway uses.                                                                                                                    
                                                                                                                                
Co-Chair  Stedman, interrupted,  and requested  a definition                                                                    
of "uplift." Mr. Van Meurs  replied that uplift meant was an                                                                    
extra deduction for tax purposes.  He stated that it was not                                                                    
a  credit  against taxes;  it  was  an extra  deduction  for                                                                    
taxes.                                                                                                                          
                                                                                                                                
Mr.  Van Meurs  stated that  there  could also  be a  volume                                                                    
progressivity system.                                                                                                           
                                                                                                                                
Mr. Van Meurs  continued to discuss slide 4.  He stated that                                                                    
a benchmark should be determined  by looking at the specific                                                                    
government interests.                                                                                                           
                                                                                                                                
9:24:42 AM                                                                                                                    
                                                                                                                                
Mr.  Van  Meurs displayed  slide  5  and  6 of  Addendum  2,                                                                    
"Fiscal  design criteria  for Alaska."  The slide  indicated                                                                    
that, from an international  perspective, a number of design                                                                    
criteria  can be  recommended in  order  to optimize  fiscal                                                                    
terms for Alaska:                                                                                                               
                                                                                                                                
   · Price progressivity should not be so strong that the                                                                       
     price  incentive index  drops  below $  0.10. For  ACES                                                                    
     this level  is reached at  a price  of about $  190 per                                                                    
     barrel                                                                                                                     
   · Cost progressivity based on average blended costs                                                                          
     should not  be so  strong that  the cost  savings index                                                                    
     drops below $0.20. For ACES  this level is reached at a                                                                    
     price  of  about  $180 per  barrel  (assuming  $25  per                                                                    
     barrel costs)                                                                                                              
   · Government take should not be uncompetitive:  For                                                                          
     Alaska it  should not  be higher  than 75  percent. For                                                                    
     ACES this is reached at a  price level of about $90 per                                                                    
     barrel.  Exploration  support:  Government  should  not                                                                    
     contribute  more than  80  percent  of the  exploration                                                                    
     costs through tax credits and  tax deductions. For ACES                                                                    
     this level is reached at $60 per barrel.                                                                                   
   · Negative PPT: Whenever tax credits or uplifts are                                                                          
     being provided  the tax income on  a consolidated basis                                                                    
     could become  negative. Sensitivity analysis  should be                                                                    
     done  to ensure  that  negative PPT  only occurs  under                                                                    
     unlikely conditions.  He stated that ACES  is deficient                                                                    
     under certain high cost - low price conditions.                                                                            
                                                                                                                                
9:29:13 AM                                                                                                                    
                                                                                                                                
Co-Chair Stedman  requested a definition of  "negative PPT."                                                                    
Mr.  Van  Meurs explained  that  the  moment the  government                                                                    
permits  a  significant  deduction   for  tax  purposes  the                                                                    
government's  income   becomes  lower.  He  added   that  if                                                                    
significant cost  deductions were  permitted, they  would be                                                                    
deducted for PPT. He explained  that PPT was a "consolidated                                                                    
tax" for  all the  oil fields in  Alaska. He  furthered that                                                                    
there could be a  cross-subsidization situation or "negative                                                                    
PPT."                                                                                                                           
                                                                                                                                
Co-Chair Hoffman  wondered what the  government contribution                                                                    
percentage would  be under  ACES at $120  a barrel.  Mr. Van                                                                    
Meurs  responded   the  government  contribution   would  be                                                                    
approximately 93 or 94 percent.                                                                                                 
                                                                                                                                
Senator  French wondered  to what  extent  Alaska was  over-                                                                    
stimulating exploration  well credits. Mr. Van  Meurs stated                                                                    
that  it would  depend on  the number  of exploration  wells                                                                    
that were currently being drilled.  He pointed out that even                                                                    
if there  was only  one exploration  well, the  state should                                                                    
not  over-stimulate the  one well.  He  stressed that  there                                                                    
should be a balance  between the development and exploration                                                                    
incentives. He  stated that that  balance does not  exist in                                                                    
Alaska.                                                                                                                         
                                                                                                                                
Co-Chair Stedman  requested a further study  of the credits,                                                                    
and implementation of the credits with the write-offs.                                                                          
                                                                                                                                
Senator Wielechowski  referred to  the prior  day's meeting,                                                                    
and the topic  of heavy oil exploration  and development. He                                                                    
queried the point  where there would be a zero  PPT. Mr. Van                                                                    
Meurs  stressed that  a government  take-away of  45 percent                                                                    
could not be achieved while  maintaining PPT, and 55 percent                                                                    
was also very difficult. He  explained that 60 percent could                                                                    
be achieved  with a viable  PPT, with  certain precautionary                                                                    
measures. He  furthered that if  investors would  not invest                                                                    
in heavy oil,  there would be no other option  but to remove                                                                    
the royalties.                                                                                                                  
                                                                                                                                
9:35:48 AM                                                                                                                    
                                                                                                                                
Senator  Thomas  looked  at  slide  2  of  Addendum  2,  and                                                                    
wondered what credits or deductions  would be applied to the                                                                    
remaining $4 of  the original $8 represented.  Mr. Van Meurs                                                                    
responded that  the $4 was  largely maintenance  capital. He                                                                    
furthered that  if the  maintenance money  was used  for the                                                                    
replacement  of facilities,  the tax  credits would  equally                                                                    
apply  to   the  replacement  of  facilities   and  original                                                                    
facilities.  Therefore, there  would be  approximately a  $1                                                                    
net  investment.   He  stressed   that  there  would   be  a                                                                    
substantial tax  reduction for the  state on that  first $4.                                                                    
Senator Thomas  estimated that  the State's  take-away would                                                                    
be approximately 75 percent. Mr. Van Meurs agreed.                                                                              
                                                                                                                                
Co-Chair Stedman  stated that the  Addendum 2  was complete,                                                                    
and the  committee would  now address the  Section 3  of the                                                                    
PowerPoint  presentation, "Proposed  terms for  existing and                                                                    
new light oil."                                                                                                                 
                                                                                                                                
Mr. Van Meurs  discussed slide 57, "Overall  framework for a                                                                    
new PPT." A new PPT  should preferably be structured in such                                                                    
a manner that it deals with the following important issues:                                                                     
The current ACES system has  serious deficiencies. A new PPT                                                                    
should   remove   those    serious   deficiencies;   a   new                                                                    
"architecture" for the  PPT needs to be created  to permit a                                                                    
greater  variety of  terms  for the  different  oil and  gas                                                                    
resources; and the system should be made simpler.                                                                               
                                                                                                                                
9:38:44 AM                                                                                                                    
                                                                                                                                
Mr. Van Meurs  displayed slide 58, "Overall  framework for a                                                                    
new PPT." A new PPT  should preferably be structured in such                                                                    
a manner that it deals with the following important issues:                                                                     
                                                                                                                                
   · The current ACES system has serious deficiencies. A                                                                        
     new PPT should remove these problems.                                                                                      
   · A new "architecture" for the PPT needs to be created                                                                       
     to permit a greater variety of terms for the different                                                                     
     oil and gas resources.                                                                                                     
   · The system should be made simpler. He stated that an                                                                       
     important  other issue  is  complexity. The  production                                                                    
     tax is far too complex  - The current complexity of the                                                                    
     production   tax   is   a   strong   disincentive   for                                                                    
     investment. It  can be  strongly recommended  to review                                                                    
     the  tax to  see what  changes  can be  made to  reduce                                                                    
     complexity.                                                                                                                
                                                                                                                                
Mr. Van Meurs shared  a personal experience regarding Repsol                                                                    
and their investment strategies and motivations.                                                                                
                                                                                                                                
9:43:38 AM                                                                                                                    
                                                                                                                                
Senator  French expressed  concern with  the idea  of having                                                                    
seven  different tax  schemes  for existing  light oil,  new                                                                    
light oil,  heavy oil, ultra  heavy oil, shale oil,  etc. He                                                                    
felt  there  was a  contradiction  between  the need  for  a                                                                    
simpler system  and the request  for seven tax  schemes. Mr.                                                                    
Van Meurs  responded that the  seven different  classes were                                                                    
very easy to understand.                                                                                                        
                                                                                                                                
Mr.  Van Meurs  looked  at slide  60,  "Deficiencies in  the                                                                    
current ACES system." The current  ACES system has five main                                                                    
deficiencies: PPT tax rates up  to 75 percent in addition to                                                                    
41 percent  corporate income tax  are too high  to stimulate                                                                    
efficiency  in operations.  The price  based sliding  scales                                                                    
and  result  in a  situation  where  under high  prices  the                                                                    
producer  is actually  better off  with a  lower price.  The                                                                    
excessive  tax credits  result in  a situation  where Alaska                                                                    
may pay all of the costs  of a well. The BOE concept results                                                                    
in  a  situation where  new  gas  production could  lead  to                                                                    
massive  losses  of  oil   based  revenues.  Under  marginal                                                                    
circumstances the  ACES system  actually creates  a negative                                                                    
PPT, in other words the  government will lose PPT on certain                                                                    
fields.                                                                                                                         
                                                                                                                                
9:47:03 AM                                                                                                                    
                                                                                                                                
Mr.   Van   Meurs   discussed   slide   61,   "Deficiencies:                                                                    
Excessive Tax  rates." The combination  of the  maximum ACES                                                                    
rate of 75 percent and  the normal corporate income tax rate                                                                    
(state and  federal) of  41 percent  creates a  combined tax                                                                    
rate of 85.25  percent under high prices.  Such an excessive                                                                    
tax rate  reduces significantly the incentive  for companies                                                                    
to be efficient because they  can only keep $0.1475 of every                                                                    
dollar  saved. This  means the  cost savings  index is  only                                                                    
14.75 percent. This is well  below the cost savings index of                                                                    
most countries.  Usually, it is  recommended to have  a cost                                                                    
savings index well over 20  percent. It should be noted that                                                                    
the combined  tax rate  of 85.25 percent  is in  addition to                                                                    
the regular royalties.                                                                                                          
                                                                                                                                
Mr.   Van   Meurs   displayed   slide   62,   "Deficiencies:                                                                    
Excessive price  progressivity." For  ACES, at  high prices,                                                                    
the  combined tax  rate becomes  so high  that there  is the                                                                    
price   incentive   performance   becomes   very   weak   by                                                                    
international standards.  This leads  to lack of interest in                                                                    
achieving the  highest prices on  an arm's length  basis and                                                                    
strong incentives to try to "transfer price".                                                                                   
                                                                                                                                
Mr.   Van   Meurs   discussed   slide   63,   "Deficiencies:                                                                    
Excessive  exploration  support." Existing  producers  under                                                                    
ACES are  entitled to the 40  percent tax credit as  well as                                                                    
all  normal  deductions  of  the  exploration  expenditures.                                                                    
This means  that at $111  per barrel, Alaska  contributes 90                                                                    
percent of the exploration costs.  At $245 per barrel Alaska                                                                    
contributes 100 percent.                                                                                                        
                                                                                                                                
Senator  French stressed  that existing  producers were  not                                                                    
exploring new  fields. Mr. Van  Meurs understood,  and added                                                                    
that current  producers were  in "extreme  harvesting mode."                                                                    
He agreed  that the existing  producers were not  focused on                                                                    
exploration.  He felt  that, from  a design  perspective, it                                                                    
did  not matter  that  there was  not  much exploration.  He                                                                    
explained that  companies were  needed to  explore, produce,                                                                    
and act  as normal companies.  He felt that there  needed to                                                                    
be a  system that was  rational and does  not over-stimulate                                                                    
exploration versus development.                                                                                                 
                                                                                                                                
9:50:07 AM                                                                                                                    
                                                                                                                                
Senator French  stressed that existing producers  could take                                                                    
advantage   of   the   enormous   subsidization   of   their                                                                    
exploration  programs,  but  the   producers  were  not.  He                                                                    
wondered  how  that  could  be   explained.  Mr.  Van  Meurs                                                                    
responded   that  since   there   was   no  attraction   for                                                                    
development, there  was no  incentive to  initially explore.                                                                    
He stressed that if  investment opportunities elsewhere were                                                                    
more attractive  than Alaska, then  the major  oil companies                                                                    
do  not feel  the need  to  spend money  on exploration.  He                                                                    
remarked  that the  exploration credit  was more  attractive                                                                    
for smaller oil companies.                                                                                                      
                                                                                                                                
Mr.   Van   Meurs   discussed   slide   64,   "Deficiencies:                                                                    
Nonsensical  cross subsidization  of gas."  The BOE  concept                                                                    
would  result  in  massive   government  revenue  losses  on                                                                    
incremental  oil production  also  gas  would be  developed.                                                                    
This does not make any sense.  It is clear that Alaska would                                                                    
not  accept such  unnecessary losses.  This in  turn impedes                                                                    
gas project development.                                                                                                        
                                                                                                                                
9:54:43 AM                                                                                                                    
                                                                                                                                
Co-Chair  Stedman  pointed  out  that DOR  was  expected  to                                                                    
present  the  estimated  numeric  of  the  current  dilution                                                                    
issue. He  estimated that they would  estimate approximately                                                                    
$80 million per  year, without a sale on gas.  Mr. Van Meurs                                                                    
reiterated that  he could not verify  the numbers. Although,                                                                    
he  stated  that  if  there   was  a  small  amount  of  gas                                                                    
production on  the North  Slope, there  would be  a negative                                                                    
BOE-depending  on   the  very   low  value  that   could  be                                                                    
attributed to  the gas. He  stressed that a small  amount of                                                                    
gas production  contributes to significant  losses. Co-Chair                                                                    
Hoffman felt  that the slide should  be titled "Decoupling."                                                                    
Mr.  Van Meurs  felt  that the  system did  not  need to  be                                                                    
decoupled.  Co-Chair Stedman  felt that  there were  several                                                                    
methods to determine a solution.                                                                                                
                                                                                                                                
9:58:28 AM                                                                                                                    
                                                                                                                                
Mr.   Van   Meurs   discussed   slide   65,   "Deficiencies:                                                                    
Negative  PPT." By  definition, for  a marginal  project the                                                                    
total negative ACES  cash flow to government as  a result of                                                                    
tax credits  and tax deductions becomes  almost identical to                                                                    
the positive cash  flow. In other words,  the net government                                                                    
receipts are low or even negative.                                                                                              
                                                                                                                                
Mr.   Van  Meurs   looked   at   slide  66,   "Deficiencies:                                                                    
Negative PPT."  With the  existence of  a tax  credit, there                                                                    
are always  economic conditions  under which  the government                                                                    
may lose more in credits  and deductions than it receives in                                                                    
income.  However, this  effect  should be  minimized in  the                                                                    
fiscal design. This is not done under ACES.                                                                                     
                                                                                                                                
Mr.  Van Meurs  looked  at slide  67,  "Proposals for  light                                                                    
oil." Proposals  for light oil production  will be discussed                                                                    
first,  based on  this discussion  the  variation for  other                                                                    
resources can  be introduced.  He stressed  that HB  110 had                                                                    
been introduced modify ACES.                                                                                                    
                                                                                                                                
Mr. Van Meurs discussed slide  68, "Proposals for light oil:                                                                    
HB110,  Analysis:  PPT   rates."  The  bracketing  procedure                                                                    
creates  a significant  lowering of  the average  PPT rates.                                                                    
The HB 110 N rates apply only  for 7 years from the start of                                                                    
production for new production.                                                                                                  
                                                                                                                                
Co-Chair Stedman  queried the difference between  the market                                                                    
value of  oil and the production  tax value of oil.  Mr. Van                                                                    
Meurs replied with slide 69.                                                                                                    
                                                                                                                                
Mr. Van  Meurs pointed  out slide  69, "Proposals  for light                                                                    
oil: HB110, Analysis: Government  take." At $100 per barrel,                                                                    
the government take from ACES  would be 76.4 percent, HB 110                                                                    
(Existing) would be  67.6 percent and HB 110  (New) would be                                                                    
64.9  percent. He  stressed that  the proposal  for existing                                                                    
production  would be  a significant  drop in  the government                                                                    
take.                                                                                                                           
                                                                                                                                
Co-Chair  Stedman surmised  that Mr.  Van Meurs  recommended                                                                    
the  undiscounted  government  take  number top  out  at  75                                                                    
percent.  Mr. Van  Meurs  stated that  there  is no  problem                                                                    
approaching  75 percent,  but he  would  not recommend  more                                                                    
than  75 percent.  Co-Chair Stedman  wondered if  the bottom                                                                    
recommendation would  be 70 percent.  Mr. Van Meurs  did not                                                                    
think it was unreasonable for new  production to be 60 to 65                                                                    
percent government take.                                                                                                        
                                                                                                                                
10:04:59 AM                                                                                                                   
                                                                                                                                
Mr.  Van  Meurs,  in  response  to  a  question  by  Senator                                                                    
Wielechowski,  explained that  the  fiscal health  situation                                                                    
should  be subjected  to different  tests. He  stressed that                                                                    
the degree of  price progressivity and the  average level of                                                                    
government take were two independent recommendations.                                                                           
                                                                                                                                
Mr.  Van  Meurs  discussed  slide   70,  "HB  110:  Existing                                                                    
Production." he  observed that HB  110 proposal  was complex                                                                    
and based  on "bracketing". He stated  that bracketing meant                                                                    
that  the  final average  rate  was  based on  the  weighted                                                                    
average  of all  the  brackets, which  means  the rate  will                                                                    
never be 50 percent. He displayed this example:                                                                                 
                                                                                                                                
     < $30.00: 25.0 percent                                                                                                     
     < $42.50: 27.5 percent                                                                                                     
     < $55.00: 32.5 percent                                                                                                     
     < $67.50: 37.5 percent                                                                                                     
     < $80.00: 42.5 percent                                                                                                     
     < $92.50: 47.5 percent                                                                                                     
     > $92.50: 50.0 percent                                                                                                     
                                                                                                                                
Mr. Van Meurs displayed slide  71, "HB 110: New production."                                                                    
For new production, the rates  will be lowered by 10 percent                                                                    
for the  first 7  years of production.  This means  that new                                                                    
production has to be "ring  fenced".  All production and all                                                                    
revenues and costs  will have to be  allocated to "existing"                                                                    
and to  "new" production. He  stressed that this  is complex                                                                    
from an administrative point of view.                                                                                           
                                                                                                                                
10:08:18 AM                                                                                                                   
                                                                                                                                
Mr. Van Meurs discussed slide  72, "Deficiencies in HB 110."                                                                    
HB 110 deals with only two of the deficiencies of ACES:                                                                         
                                                                                                                                
   · PPT tax rates up to 75 percent in addition to 41                                                                           
     percent corporate income tax are too high to stimulate                                                                     
     efficiency in operations.                                                                                                  
   · The price based sliding scales and result in a                                                                             
     situation where under high prices the producer is                                                                          
     actually better off with a lower price.                                                                                    
   · The excessive tax credits result in a situation where                                                                      
     Alaska may pay all of the costs of a well.                                                                                 
   · The BOE concept results in a situation where new gas                                                                       
     production could lead to massive losses of oil based                                                                       
     revenues.                                                                                                                  
   · Under marginal circumstances the ACES system actually                                                                      
     creates a negative PPT, in other words the government                                                                      
     will lose PPT on certain fields.  House Bill 110 deals                                                                     
     with excessive price rate and progressivity                                                                                
                                                                                                                                
Mr. Van Meurs  discussed slide 73, "Deficiencies  in HB 110"                                                                    
In  addition,  HB  110  creates  an  entirely  new  problem.                                                                    
Specifying  different   tax  rates  for  Existing   and  New                                                                    
Production  requires  tax  payers to  submit  different  tax                                                                    
returns for these two classes  of production. This is called                                                                    
ring  fencing. This  in  turn means  that  all revenues  and                                                                    
costs need to be allocated  to "existing" and "new". This is                                                                    
complex to administer and could  lead to significant revenue                                                                    
losses  for the  State. He  explained that  HB 110  does not                                                                    
specify how  this process  would have to  take place,  so HB
110 is not a viable alternative to ACES.                                                                                        
                                                                                                                                
Mr. Van  Meurs presented  slide 74, "BOE  complications." An                                                                    
important drawback  of ACES is  the BOE problem.  This means                                                                    
that in case major oil  companies would propose a new Alaska                                                                    
LNG export project to the  Pacific, the entire fiscal system                                                                    
has to be revised again.  This is an unnecessary obstacle to                                                                    
the  introduction of  a  new gas  project.  It is  therefore                                                                    
essential that in any revision  of ACES this problem is also                                                                    
dealt with in  advance.  This would permit to  add gas terms                                                                    
to  the package  later  (or immediately)  without having  to                                                                    
change  oil  terms again.  ACES  does  not resolve  the  BOE                                                                    
problem. A  gas project  would have to  be started  all over                                                                    
again.                                                                                                                          
                                                                                                                                
Mr. Van  Meurs displayed  slide 75, "PVM  Proposal: Existing                                                                    
and New Production." The PVM  Proposal is going further than                                                                    
merely creating  new levels of government  take for existing                                                                    
and  new  production.  The  proposal   also  creates  a  new                                                                    
"architecture" to which  terms for heavy oil,  shale oil and                                                                    
natural gas can  be easily added, and  the proposal resolves                                                                    
all the deficiencies associated with ACES.                                                                                      
                                                                                                                                
Mr. Van Meurs  discussed slide 76. He explained  that HB 110                                                                    
for  New Production  is  equal to  a  much simpler  concept,                                                                    
which is:                                                                                                                       
                                                                                                                                
   · 25 percent flat PPT                                                                                                        
   · 20 percent tax credit, plus a                                                                                              
   · 2.25 percent severance feature                                                                                             
                                                                                                                                
The severance tax  feature is no different from  the way the                                                                    
severance  tax  used  to  be  calculated  in  Alaska.    The                                                                    
severance  tax is  a percentage  of the  value of  the gross                                                                    
production  less  the  royalty.  He  provided  the  example:                                                                    
royalty of  12.5 percent and an  oil price of $  100, a 2.25                                                                    
percent severance feature would be  equal to: 2.25 percent *                                                                    
87.5 percent * $ 100 = $ 1.96875 per barrel.                                                                                    
                                                                                                                                
10:15:15 AM                                                                                                                   
                                                                                                                                
Mr.  Van Meurs  discussed slide  77, "PVM  Proposal for  New                                                                    
Production." In  order to make  the severance  feature match                                                                    
the  government  take of  HB  110  for new  production,  the                                                                    
following price sensitive sliding scale is proposed:                                                                            
                                                                                                                                
   · The sliding scale starts at an oil price of $60 per                                                                        
     barrel                                                                                                                     
   · Between an oil price of $60 and $180 per barrel, the                                                                       
     severance feature would increase with 0.05 percent per                                                                     
     dollar increase, reaching a value of 6 percent at $                                                                        
     180 per barrel                                                                                                             
   · Thereafter, the sliding scale would increase 0.1                                                                           
     percent in order to reach a maximum of 15 percent at                                                                       
     $270 per barrel.                                                                                                           
                                                                                                                                
Mr. Van Meurs looked at  slide 78, "New 'architecture'." The                                                                    
PVM Proposal creates  a new "architecture" which  is not BOE                                                                    
based.  The severance feature  is simply gross revenue based                                                                    
for oil (after the royalty)  and therefore it does not apply                                                                    
to gas.  As a result PPT  revenues from oil remain  the same                                                                    
if also gas is produced.   This solves a major deficiency of                                                                    
ACES.  Also  excessive  exploration  support  is  eliminated                                                                    
because it  is proposed to  limit tax credits to  20 percent                                                                    
and  not increase  tax  credits to  40  percent for  certain                                                                    
exploration expenditures, and by  creating a maximum PPT tax                                                                    
rate of  25 percent  and corporate income  tax rate  of 41.1                                                                    
percent, for a total maximum of 55.75 percent.                                                                                  
                                                                                                                                
Mr.  Van Meurs  displayed slide  79, "PVM  Proposal for  New                                                                    
Production." The PVM proposal  results in almost exactly the                                                                    
same government  take as HB  110 for new production  for the                                                                    
entire price range from $60 to $160.                                                                                            
                                                                                                                                
Senator Wielechowski  wondered if the proposals  would apply                                                                    
to  heavy  oils  within  the legacy  fields  Mr.  Van  Meurs                                                                    
replied that  he would later  present his  modifications for                                                                    
existing, heavy oil, and gas.                                                                                                   
                                                                                                                                
Mr.  Van Meurs  addressed slide  80, "PVM  Proposal for  New                                                                    
Production."  The main advantages of the PVM Proposal are:                                                                      
                                                                                                                                
   · Much easier to administer                                                                                                  
   · Can be consolidated with existing production, so no                                                                        
     need for  ring fencing an "architecture"  which permits                                                                    
     other  resources to  be added  to the  fiscal terms  No                                                                    
     excessive tax rates,  in fact a combined  rate of 55.75                                                                    
     percent.                                                                                                                   
   · No excessive price progressivity                                                                                           
   · No excessive exploration support                                                                                           
   · No nonsensical cross subsidization of gas based on BOE                                                                     
     values                                                                                                                     
   · Reduced negative PPT characteristics                                                                                       
                                                                                                                                
Senator  French wondered  if there  would be  an explanation                                                                    
for  how to  avoid  ring-fencing by  using  a decline  curve                                                                    
method. Mr.  Van Meurs stated that  he would show that  in a                                                                    
later slide.                                                                                                                    
                                                                                                                                
10:20:16 AM                                                                                                                   
                                                                                                                                
Mr. Van Meurs discussed  slide 81, "Alternative Proposal for                                                                    
Existing Production." He  stated that it is now  easy to add                                                                    
a  proposal  for  existing production.  Terms  for  existing                                                                    
production  could be  close to  the current  government take                                                                    
levels of ACES.  It is not necessary to  give up significant                                                                    
revenues. Existing production terms could also be based on:                                                                     
                                                                                                                                
   · A flat 25 percent PPT                                                                                                      
   · 20 percent tax credits                                                                                                     
   · A severance feature starting a $60 with 0.2 percent                                                                        
     increases per dollar increase in price up to $130 per                                                                      
     barrel and from there 0.1 percent up to a maximum of                                                                       
     20 percent                                                                                                                 
                                                                                                                                
Mr.  Van  Meurs  displayed  slide  82,  "All  Proposals  for                                                                    
Existing and New Production." The  PVM Proposal for existing                                                                    
production would be result in  a much higher government take                                                                    
than HB  110 for existing  production. The PVM  proposal for                                                                    
new production is about equal to HB 110 for new production.                                                                     
                                                                                                                                
Mr.  Van Meurs  discussed the  Department of  Revenue's ACES                                                                    
Tax  Report from  2011. He  pointed out  that the  long-term                                                                    
forecast, and remarked  that if there was  no accounting for                                                                    
extra layers  of oil,  then the decline  would be  5 percent                                                                    
per year. He stressed that  there were about 625,000 barrels                                                                    
per  day.  He  noted  that there  were  significant  decline                                                                    
forecasts.  He   stressed  that  DOR  only   considered  new                                                                    
production when  determining forecasts.  He felt  that there                                                                    
were discrepancies  based on all production  versus existing                                                                    
production.                                                                                                                     
                                                                                                                                
Mr.  Van Meurs  looked at  slides 83  and 84,  "Old and  New                                                                    
Production." He  stated that HB  110 does not  determine how                                                                    
to  distinguish between  new oil  and existing  oil.   It is                                                                    
proposed to use the following methods:                                                                                          
                                                                                                                                
1.  Decline  curve method.  With  the  decline curve  method                                                                    
Alaska  would  establish  the average  production  for  each                                                                    
company  in  2011. An  exponential  decline  curve would  be                                                                    
established  per  company.  For  instance one  could  use  6                                                                    
percent  per year  for all  companies for  light production.                                                                    
Any  production over  the decline  curve  per company  would                                                                    
qualify as "new".  The main advantage of the  method is that                                                                    
is goes  to the essence  of the  problem in Alaska.  It also                                                                    
strongly  stimulates investment  by  new companies.   It  is                                                                    
easy to  administer. The main disadvantage  is that existing                                                                    
companies may  be rather  differently affected.   Therefore,                                                                    
this method needs to be complemented with other options.                                                                        
                                                                                                                                
2. New non-producing lease method.  Another simple method is                                                                    
to  consider "new"  production,  as  production from  leases                                                                    
which were  not in  production prior  to December  31, 2011.                                                                    
The  main advantage  of the  method is  that it  is easy  to                                                                    
administer   and   is   a   well-established   international                                                                    
practice.  It  would encourage new investment  in new leases                                                                    
with fields which maybe more expensive.                                                                                         
                                                                                                                                
3. New approved program method.  In principle it is possible                                                                    
for  existing  producers   to  make  specific  comprehensive                                                                    
proposals to the Alaska Government  for new investments that                                                                    
will increase  production from existing fields.   This would                                                                    
relate  to  programs that  would  be  in excess  of  ongoing                                                                    
investments.                                                                                                                    
                                                                                                                                
10:29:08 AM                                                                                                                   
                                                                                                                                
Mr. Van Meurs displayed slide  85, "Old and New Production."                                                                    
These programs could include:                                                                                                   
                                                                                                                                
   · The drilling of new more expensive deeper or shallower                                                                     
     reservoirs,                                                                                                                
   · Enhanced recovery projects                                                                                                 
  · Horizontal well drilling projects in thin reservoirs,                                                                       
   · Extensive new infill drilling beyond current rates, or                                                                     
   · Any application of new technology                                                                                          
                                                                                                                                
He stated that DNR would  establish the base line production                                                                    
above which production  would be considered "new"  on a year                                                                    
by year basis, based on reservoir and other studies.                                                                            
                                                                                                                                
Senator  Wielechowski  wondered   what  the  state's  fiscal                                                                    
impact would be  from Mr. Van Meur's proposal  over the next                                                                    
five years. Mr.  Van Meurs replied that compared  to HB 110,                                                                    
his  proposal  would  allow  for  significant  retention  of                                                                    
revenue. Although,  compared to ACES, some  revenue would be                                                                    
lost.                                                                                                                           
                                                                                                                                
Senator Wagoner  looked at slide  56, and wondered  if there                                                                    
was  any reason  why  there  was not  a  combination of  the                                                                    
resources  of  the same  percentage  levels.  Mr. Van  Meurs                                                                    
replied   that  he   would  later   explain  his   different                                                                    
conclusions for gas, heavy oil, and shale oil.                                                                                  
                                                                                                                                
Co-Chair Stedman discussed housekeeping.                                                                                        
                                                                                                                                
ADJOURNMENT                                                                                                                   
                                                                                                                                
10:34:17 AM                                                                                                                   
                                                                                                                                
The meeting was adjourned at 10:34 AM.                                                                                          

Document Name Date/Time Subjects
Addendum2.ppt SFIN 2/14/2012 9:00:00 AM
Arctic and Alaska Oil Economics
Replacement Addendum 1.ppt SFIN 2/14/2012 9:00:00 AM
Arctic and Alaska Oil Economics