Legislature(1995 - 1996)
04/19/1995 08:15 AM Senate FIN
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MINUTES
JOINT MEETING
HOUSE AND SENATE FINANCE COMMITTEES
April 19, 1995
8:15 a.m.
TAPES
SFC-95, #35, Side 1 (420-end)
SFC-95, #35, Side 2 (575-114)
CALL TO ORDER
Senator Steve Frank, Co-chairman, Senate Finance Committee,
convened the Joint House and Senate Finance Committee
meeting at approximately 8:15 a.m.
PRESENT
Senators Representatives
Sen. Frank Rep. Martin
Sen. Halford Rep. Brown
Sen. Donley
Sen. Phillips
Sen. Rieger
Sen. Sharp
Representative Mark Hanley, Co-chairman, House Finance
Committee arrived soon after the meeting began. Senator
Zharoff and Representatives Foster, Grussendorf, Kelly,
Kohring, Mulder, Navarre, Parnell, and Therriault did not
attend.
ALSO ATTENDING: Representative Gail Phillips, Speaker of
the House of Representatives; Wil Condon, Commissioner,
Dept. of Revenue; Annalee McConnell, Director, Office of
Management and Budget; Dr. Charles Logsdon, Chief Petroleum
Economist, Oil and Gas Division, Dept. of Revenue; Nancy
Slagle, Director, Division of Budget Review, Office of
Management and Budget; Mike Greany, Director, Legislative
Finance Division; and aides to committee members and other
members of the legislature.
SUMMARY INFORMATION
Spring Revenue Forecast
Presentation by Dr. Charles Logsdon
Department of Revenue
Upon convening the joint meeting, Senate Finance Co-chairman
Steve Frank invited Commissioner Wil Condon, OMB Director
Annalee McConnell, and Chief Petroleum Economist Chuck
Logsdon to join committee members at the table.
WIL CONDON, Commissioner, Dept. of Revenue, advised that the
department lowered its mid-case forecast for FY 96 general
fund revenue by $184 million from the November forecast.
The reduction is based on:
1. Present belief that North Slope production will be
down 92,000 barrels a day from the fall forecast.
2. A 20-cent reduction in the destination price
forecast from $16.72 to $16.52 a barrel.
3. Expectation that transportation costs that
determine what the state receives at the wellhead
will be 51 cents a barrel higher
than in November.
The Commissioner referenced the department's five-year
forecast presenting high, medium, and low scenarios and
acknowledged that in some years prices and volume would
achieve the high case. However, the market is likely to
decrease to the low level as well. The department thus
plans around the mid case. At the present time, the price
of ANS crude is over $18.50 a barrel. The department
forecast for FY 96 is $16.52. While FY 96 may prove to be a
high year, when projecting basic market fundamentals for the
next few years, the department does not foresee a dramatic
change. Market fundamentals call for a price, in 1995
terms, of $16.50 a barrel.
Speaking to volume, Mr. Condon referenced a recent
presentation by Cambridge Research. He noted that the
presentation was perceived as optimistic in terms of
production projections. Department projections through 2002
exceed those of Cambridge.
ANNALEE McCONNELL, Director, Office of Management and
Budget, next spoke to the relationship between projections
and the upcoming FY 96 budget. She referenced the lowering
of the expected oil price between the fall and spring
revenue forecast and stressed need for a "much firmer fiscal
plan for the state." She cautioned that in getting to that
point it does not make sense to take hasty action which
could have a negative impact on the overall state economy.
However, the administration will be more closely tracking
what occurs on a month-by-month basis. There is opportunity
for mid-year course correction, if necessary.
Mrs. McConnell stressed need to work closely with the long-
range fiscal planning commission. She reiterated her
caution against action that could drive state and local
economies downward. The administration believes it is on
track in terms of bringing the budget down from the amount
originally proposed in February. It would not, however, be
prudent to take drastic action.
CHUCK LOGSDON, Chief Petroleum Economist, Dept. of Revenue,
next spoke to members. Directing attention to a handout
(copy appended to these minutes), Mr. Logsdon noted a
projection of $1.885 billion for FY 95. Due to higher oil
prices, the department will attempt to update that number by
May 1. Mr. Logsdon estimated that revenues would amount to
approximately $1.9 billion, if oil prices remain high.
Figures for FY 96 evidence the largest adjustment from the
fall forecast. The projection is $1.775 billion for FY 96
and $1.828 billion for FY 97. The department is fairly
confident that, in nominal dollar terms, the state "can
probably bring in something around $1.9 billion a year," if
production and price remain close to the mid-case level.
Referencing the second page of the handout, Mr. Logsdon
explained that if the forecast were to be characterized by
one assumption, it would be production. The department made
a "fairly radical adjustment downward" in production
estimates in the short term. For the last several years,
the department held with a "fairly optimistic" projection
from Prudhoe Bay in FY 95 and 96. The department felt that
with commissioning of the GHX2 project, decline at Prudhoe
Bay could be mitigated to a significant degree. More
experience as the project progresses indicates that not all
of the oil originally anticipated will be recovered.
Changes in production numbers reflect a one-time downward
adjustment compounded by weather-related down time and
unplanned seasonal maintenance on the Prudhoe Bay oil field.
The foregoing resulted in a 92,000 barrel decline in
production estimates for the North Slope from the fall
forecast. That is the bad news.
The good news is that there is much additional activity on
the slope. An aggressive plan would expand Milne Point up
to approximately 50,000 barrels a day. Milne Point
facilities will thus be moving oil to market at "something
closer to what the original plans suggested they would be."
That will be achieved because of discovery of new,
producible pay made possible through technology and
additional exploration. A large scale enhanced oil
recovery (LSEOR) project will move natural gas liquids
through the pipeline and enhance recovery at Kuparuk.
Commencement of additional well drilling at both Kuparuk and
Prudhoe Bay will extend production further into the future
than earlier anticipated.
End: SFC-95, #35, Side 1
Begin: SFC-95, #35, Side 2
The decline rate for the North Slope now appears to be
closer to 4%. When the production curve is matched with
that for revenue, it evidences a downturn for the next
several years but subsequent upward movement over the next
five or six years to around $1.9 billion a year in general
fund unrestricted moneys.
Adjustments in production numbers highlight changes in the
tax rate. Mr. Logsdon noted that the severance tax is
subject to the economic limit factor (ELF). The ELF is a
direct function of the number of barrels produced and the
number of wells that produce them. If the number of wells
remains the same or increases, and production drops, on
average that lowers the amount of oil coming out of each
well. That is exactly what lowers the ELF. Page 3 of the
handout reflects the fact that the tax rate is beginning to
come down. It "takes a fairly good sized drop between 95
and 96." Also of importance is the fact that Pt. McIntyre
is "incredibly productive" and is paying substantial
severance tax. It is producing upwards of 140,000 barrels a
day out of wells producing 7,000 to 8,000 barrels a day.
The ELF is thus close to .9, the maximum rate.
The forecast assumes that in order to keep production at
those levels, producers may double the number of wells in
the field. The resulting effect will be that production
remains the same but the tax drops. Every 1% drop in the
ELF at $10 a barrel at the wellhead costs the state "about
$7 million." In 96, the state will face "nearly a 5% drop
in the tax rate." That translates to $35 to $40 million.
Referencing page 4 of the handout, Mr. Logsdon explained
that the fall forecast used $16.72 as the base price for FY
96. That was rolled back approximately 20 cents for the
spring forecast because of a serious push by Iraq to have
the embargo lifted. The United Nations declined to do so
with the exception of a limited sale of up to $2 billion
worth of oil to fund war reparations and provide food and
medicine which the United Nations would distribute to the
Iraqi people. That arrangement was unacceptable to Iraq.
The world view presented by Cambridge is consistent with
that of the Dept. of Revenue. On the demand side, economic
growth is expected to be relatively robust for the next five
years, with the exception of Japan. The global increase in
oil consumption is approximately 2 million barrels a day.
Of that, OPEC picked up less than half, and non-OPEC
benefited from the greater share.
Speaking to supply, Mr. Logsdon noted that non-OPEC
production continues to increase, and there are projections
of another large increase from the North Sea next fall.
That is anticipated to exert downward pressure on price, and
it is showing "up only a little bit in the futures market"
where contract prices for next fall are "just a few pennies
lower than the cash price today."
The key issue for OPEC is Iraq and its 3 million barrels a
day which have been sitting on the sidelines for
approximately five years. Although most feel this oil will
not reenter the market while Saddam Hussein is president, it
remains a cause for concern.
The real area of potential growth continues to be the former
Soviet Union, countries in the Middle East, and areas around
the Caspian and Black Seas. The chief obstacle to
development is getting the oil to market. In the long term,
this represents a huge amount of oil that could enter the
market.
Mr. Logsdon cautioned that in not producing and selling its
3 million barrels a day, Iraq is banking 90 to 100 billion
barrels in reserves. Those barrels will be available at
some time in the future.
When evaluating all of the foregoing, the Dept. of Revenue
projects a tendency for mid-scenario oil in the $16.50 a
barrel range. It further assumes that the mid-case price
will keep pace with inflation. It is further projected that
the price will be close to $16.50 per barrel purchasing
power in the year 2005.
Mr. Logsdon explained that for planning purposes, some oil
companies focus on the low scenario, $15.00 oil. Market
dynamics that move the price in that direction may always
occur. He cautioned against reliance on the high projection
of $18.00 and noted that an $18.00 year may be followed by a
$13.97 year. Due to that volatility, a long-term planning
price of $16.50 is more prudent.
Speaking to pricing, Mr. Logsdon noted that Alaska
experiences "some fairly big deductions from that sales
price" in determining the wellhead value upon which taxes
and royalties are based. He next referenced a graph
entitled, "Transportation Costs to Lower 48" and explained
that it rolls together both the TAPS charge and tanker
costs. FY 95 reflected a "big jump" in the cost of moving
ANS to market. The largest share resulted from the 1995
TAPS filing evidencing unanticipated operating expenses.
Hundreds of millions of dollars were expended by Alyeska for
electrical work, corrosion repair, etc. That caused the
tariff to be 50 cents higher than anticipated. Most of the
20 to 30-cent increase in marine transportation reflects
"increased . . . 90-type regulatory costs." These costs are
allowed deductions against the severance tax.
Mr. Logsdon referenced the next graph and noted decreases in
tanker and pipeline costs between 1995 and 1998. The
decrease for marine transportation indicates that fewer
barrels of ANS will be transported to the gulf coast, and
average transportation costs will thus drop. Further,
depreciation on capital pipeline costs has declined but will
again increase beyond the year 2000 as additional capital
investments are needed. Projected declines in operating
costs reflect a reduction in the number of barrels shipped
through the pipeline. Decommissioning of facilities (pump
stations) will also lower fixed costs. The department is
projecting transportation costs of below $4.50 a barrel over
the next five to six years.
Mr. Logsdon next directed attention to the "Alaska State
Revenue Matrix" and pointed to projected revenue of $1,948
million based on a price of $18.00 and FY 96 production of
1.50 million barrels. That number is approximately $200
million higher than the current base case.
Responding to a question from Co-chairman Halford concerning
the high and low range of production for FY 96, Mr. Logsdon
advised of a single point estimate for production for the
short term. The Co-chairman voiced concern that although
production was a "big component of the last error" no
potential range is shown. Mr. Logsdon concurred and
explained that that is one of the reasons the sensitivity
matrix was developed.
Representative Martin voiced his belief that, at this time,
Alaska's welfare depends more upon production than price.
He then asked if it is possible to obtain additional
information from producers and suggested need for a five-
year production average. Commissioner Condon explained that
the individual responsible for production estimates
carefully reviews development plans submitted by operators
and reviews production forecasts with pertinent companies.
That results in "the best we can do" in terms of discussions
with those responsible for investment of capital moneys in
an attempt to "get the hydrocarbons out of the ground."
In response to a further question from Representative
Martin, Commissioner Condon explained that wells are not
being shut down because they are not producing profitably.
They are being shut down because, in the mix of oil and gas
production, it is not optimum to produce from particular
wells because of the high amount of gas produced with the
oil. Facilities at Prudhoe Bay can handle only a certain
amount of gas. As the field matures, the amount of gas
produced per barrel of oil increases daily. The amount of
oil produced is a function of ability to handle the gas that
comes out of the ground with the oil.
Representative Martin asked if the state would sustain a 3
to 4% production loss per year into the future.
Commissioner Condon acknowledged there would be production
loss each year. Responding to further questions from the
Representative, the Commissioner stressed need to anticipate
the range between the low and high-case scenario. The
budget should be planned based on selection of the right mid
case over the longer term.
Senator Rieger referenced potential for development of
Badami and the String of Peals fields. He then inquired
concerning components of the department forecast that result
in a future (1998-99) 300,000 to 400,000 barrel discrepancy
when compared to Cambridge numbers. Mr. Logsdon voiced his
belief that the two projections are "pretty close . . .
through 2002." Beyond that, Cambridge speaks to liquid
production capacity. The department has not been able to
develop definitive numbers for that. He added that the
department has not "explicitly included production from
Badami." The department opted not to do so because it has
not been well delineated. Information over the next several
months should better define the number of barrels that might
be available. Other production mentioned by Cambridge
remains a mystery. The department has not estimated
production from Hammerhead and other wells that have been
drilled. The state forecast includes ability to produce
from North Star, Seal Island, and West Sak. Those fields
are not now in production because of large cost hurdles.
Technological advancements may make them producible at a
reduced cost. Alaska does not have, in either its
reservoirs or known discoveries, sufficient barrels to
justify Cambridge production numbers.
Commissioner Condon clarified that through 2002, the
department's forecast is higher than Cambridge. He
reiterated that the department projection does not include
production from Badami. The Cambridge projection does. At
2002, Cambridge "picks up two chunks." They include known
fields for which no development plans have been announced as
well as new discoveries which have not occurred. That is
where volumes within the two projections diverge. At that
point the Dept. of Revenue estimate begins to decline, while
the Cambridge estimate increases. For producing fields, the
department's projection is more optimistic than that of
Cambridge.
House Speaker Gail Phillips asked if the department
requested detailed information on future numbers from
Cambridge. Mr. Logsdon said the department received the
actual numbers but not requested backup information
underlying the numbers.
Discussion followed between Senator Sharp and Mr. Logsdon
reiterating earlier comments regarding increased operating
costs that gave rise to the tariff increase in 1995. Mr.
Logsdon explained that the state does not absorb "the entire
blow." The state pays 25 cents for every dollar increase in
cost through lower wellhead value and lower severance tax
and royalties. The $300 to $400 million increase in
unanticipated operating expenditures relates to the fact
that the pipeline is getting old. Repairs must be
undertaken to keep the system in tact.
Senator Rieger advised of information from Cambridge
indicating that future reserves relate to three areas with
estimated reserves of 150 to 300 million barrels.
ADJOURNMENT
The meeting was adjourned at approximately 9:05 a.m.
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