Legislature(2009 - 2010)SENATE FINANCE 532
02/23/2010 09:00 AM Senate FINANCE
| Audio | Topic |
|---|---|
| Start | |
| Industry Testimony - Oil & Gas Tax Review | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE FINANCE COMMITTEE
February 23, 2010
9:03 a.m.
9:03:12 AM
CALL TO ORDER
Co-Chair Stedman called the Senate Finance Committee
meeting to order at 9:03 a.m.
MEMBERS PRESENT
Senator Lyman Hoffman, Co-Chair
Senator Bert Stedman, Co-Chair
Senator Charlie Huggins, Vice-Chair
Senator Johnny Ellis
Senator Dennis Egan
Senator Donny Olson
Senator Joe Thomas
MEMBERS ABSENT
None
ALSO PRESENT
Marilyn Crockett, Executive Director, Alaska Oil & Gas
Association (AOGA); Wendy King, Vice President, External
Affairs, ConocoPhillips Alaska; Senator John Coghill;
Senator Joe Paskvan
PRESENT VIA TELECONFERENCE
None
SUMMARY
2010 OIL & GAS PRODUCTION TAX REVIEW
^Industry Testimony - Oil & Gas Tax Review
9:03:21 AM
MARILYN CROCKETT, EXECUTIVE DIRECTOR, ALASKA OIL & GAS
ASSOCIATION (AOGA), referenced a handout entitled,
"Testimony of the Alaska Oil and Gas Association to the
Senate Finance Committee about the Failings of the ACES
Production Tax "(copy on file). She noted AOGA is the trade
association for the oil and gas industry in Alaska. The
fourteen members account for the majority of oil and gas
exploration, development, production, transportation,
refining, and marketing activities in the state. Members of
the AOGA Tax Committee approve of the following testimony.
Ms. Crockett read portions of the following testimony.
First of all, we apologize to the committee for the
fact that our testimony today cannot be a detailed or
comprehensive review of the many problems, issues and
failings of ACES. Instead, it is only an overview, a
snapshot from 50,000 feet if you will, of what's wrong
or going wrong with this tax. And we can offer at
this time only a handful of specific examples to
illustrate these problems - not because the examples
are few, but because we were simply unable before this
hearing to compile the many more examples that we
could otherwise have presented. Also, during your
hearings last week you were given information that was
either inaccurate, incomplete or misleading, and we
would like to use part of our time with you today to
set the record straight on a number of those points.
ACES was proposed and enacted with two primary goals:
One, to raise the amount of production taxes from what
the state would have received under either the old
ELF-based tax or the "Petroleum Production Tax" - also
known as the "PPT" - that replaced the ELF. And two,
to attract new capital investment for oil and gas
exploration, development and production on the massive
scale that is needed to mitigate the decline in
production rates as the resource is depleted. These
goals seem fundamentally inconsistent with one
another. How can the tax be raised for the industry
and at the same time have the tax attract greater
industry investment here?
ACES' answer was to take the tax deduction and tax
credits for new capital investments that PPT first
created, modify the credits to make them less
attractive, and substantially increase the amount of
production taxes on the oil and gas industry. There
are numerous technical problems in ACES that need to
be fixed and many others that should be fixed simply
as a matter of tax policy.
At the outset, let me reiterate AOGA's primary
concern, that we believe the tax rates under ACES are
too high and overshoot the optimum point where total
state revenues, Alaska jobs and economic growth are
maximized of the remaining life of the fields. We
have said it before. No one ever taxed economic
activity and prosperity into existence. We could
spend hours discussing prospectivity, tax rates and
what is needed to ensure Alaska has a tax rate that
encourages investment, in fact we have on several
previous occasions done so. Our intention is not to
rehash those arguments at this time but to educate the
committee on just a few structural issues and point
out our contrary viewpoint regarding some of the
state's testimony. We expect the dialog on what is the
right tax rate to be ongoing and more appropriate for
another time.
9:07:01 AM
Co-Chair Stedman suggested that Ms. Crockett address some
of the issues specifically. Ms. Crockett stated that the
focus of her presentation was to address issues brought up
by the administration and other testifiers.
Ms. Crockett continued to describe the lack of clarity in
ACES.
Another major issue with ACES is the regulations the
Department of Revenue has adopted and is considering
adopting. In order for ACES to work properly and
have its full beneficial influence on investment
decisions, ACES must be as clear and transparent as
possible. The essential importance of this clarity is
the same regardless of what the tax rate and
progressivity might be, or what the percentage is for
the tax credit from a capital investment. The basic
structure of ACES - the foundation for it to have any
chance of success - depends not only on having a
reasonable rate of tax, but on having clarity and
transparency with as little ambiguity as possible.
Despite what you may have heard last week, the
department's regulations fail this test.
Even though the tax rate might be very high for
current production from past investments, making a new
investment will reduce the tax on that production
under ACES and will also generate a credit against the
remaining tax. For example, if the tax rate with
progressivity is 50%, investing a dollar here for a
regular capital project will reduce the tax on current
production by 50% of that dollar, and in addition it
will also generate a 20% tax credit. Thus, investing
that dollar would save some 70¢ of tax on current
production. This 70¢ tax savings would show up in the
economics for that investment under metrics like Net
Present Value and Internal Rate of Return, and it
would make that investment seem more attractive.
The fundamental problem with this approach is that,
even though it looks good in theory, for it to succeed
in the real world it is necessary that the person
making the decision about investing this dollar will
be confident - at the time of making the decision -
that the full 100 cents of the dollar will be
recognized and the resulting benefits from investing
this dollar will actually be 70 cents. If the tax is
ambiguous, or if a substantial portion of this dollar
could be unexpectedly disallowed by the state, a
prudent decision-maker will reduce the expected tax
benefit from the 70¢ it should have been in this
hypothetical example. This is why "Clarity" is ACES'
middle name: "Alaska's Clear and Equitable Share."
Suppose, for instance, the decision-maker thinks only
60¢ of the invested dollar will actually be recognized
under ACES. Then a 60¢ deduction at my hypothetical
50% tax rate would be worth 30¢, and the 20% tax
credit would be 12¢, making a total tax benefit of
only 42 cents. This difference between a 42¢ tax
benefit and a 70¢ one may not sound like very much,
but if the hypothetical project being evaluated costs
$100 million, it means $28 million would be drained
out of its economic performance as perceived by the
investment decision-maker, simply because of this lack
of clarity in the tax. Put in these terms, one can
begin to appreciate how the go/no-go decision for such
an investment could be affected by a lack of clarity
in ACES.
And the key point here is: this adverse impact on the
investment decision will occur even if the Department
of Revenue, after audit, would have ultimately found
100¢ of that dollar to be completely justified and
proper. In other words, the tax benefit actually
allowed would turn out to be 70¢ for that dollar, but
only 42¢ of that benefit was taken into account by the
decision-maker at the time of the investment decision.
This is a terrible dilution or waste of the incentive
for investing that ACES is designed to give.
9:09:53 AM
Ms. Crockett described an example - Attachment A (copy on
file).
9:10:11 AM AT-EASE
9:13:13 AM RECONVENED
Co-Chair Stedman requested information about leasehold
expenditures.
Ms. Crockett reiterated the example of a one dollar
investment and the fundamental problem with that approach.
The tax benefit would be reduced. She repeated the second
example using a 60 cent deduction. She reviewed the key
point previously made.
9:17:45 AM
Ms. Crockett referred again to Attachment A which points
out the uncertainties created by the Department of Revenue.
9:18:57 AM AT-EASE
9:19:38 AM RECONVENED
Ms. Crockett continued to paraphrase from her written
testimony.
There are clarity issues with the ACES statutes
themselves, but as I mentioned, the regulations that
the Department of Revenue has adopted and is in the
process of adopting are compounding and re-compounding
the uncertainty and lack of clarity. Attached to the
written copies of this testimony is an attachment
illustrating the kinds of uncertainty being created
unnecessarily by the department. I will not take the
committee's time to read that attachment now, but I
invite you to peruse it at your leisure.
9:21:04 AM
Ms. Crockett continued to read.
Bad as it is, that example is only the tip of the
iceberg in terms of what is going wrong with the ACES
regulations. There are many, many more examples that
we could offer. The written comments and testimony
submitted to the department by AOGA and by individual
companies about the issues and problems with the draft
and final regulations run to nearly 200 pages - just
on the subject of deductible lease expenditures. That
total does not include what we told the department
about its tax-credit regulations. And, as Deputy
Commissioner Marcia Davis acknowledged to this
committee last week, we expect to have a lot of
comments about the transportation-cost regulations
that the department is proposing to adopt, especially
since the department is dispensing with the public
workshop process and going straight to the public
hearing for actually adopting them.
One final problem with the ACES regulations that I
would draw to your attention is the fact that the
Department of Revenue has totally failed to address
the question of how the non-operating working-interest
owners in a unit or other oil and gas property are
supposed to comply with all these requirements. Each
month the non-operating owners are required by ACES to
report and pay estimated taxes, and on March 31 of the
following year they have to "true up" those estimates
to the actual results for the year. All that they
have available when these reports and payments come
due are the billings that they receive from the
operator for their respective shares of the unit's
costs. Even though the non-operating interests can
and do audit the operator's billings to them, their
audits are done for several years of billings at a
time, and the billing periods in question for those
audits are in the past. These audits rarely if ever
address billings for the current year because it would
be premature to try to audit them: the operator's own
books and records for the year won't even close and
become properly auditable until after the year ends.
9:24:21 AM
This puts the non-operating working-interest owners in
an even worse spot than their operator in terms of
clarity about how much of what they pay for costs
being billed to them will end up actually being
deductible under ACES. The regulations fail to take
into account the fact that this "flying blind"
situation about deductibility is the economic reality
that these non-operators must face and deal with - and
in particular, the one they face when it comes to
making new investments in their unit or property.
Their actual cash outlays for a new investment will
be, in the first instance, whatever the operator bills
them as their share of the costs for that investment
or project - even if their audit of the operator's
billings ultimately finds material error in them, that
would be a cash outlay or receipt for the non-
operators at that later time.
So, to go back to my example earlier, these non-
operators have no way of knowing whether one dollar of
new investment will end up being fully recognized for
ACES and generate a deduction worth 50¢ and a tax
credit of another 20 cents. Or whether, instead, only
60¢ of that dollar will be recognized, with the ACES
tax benefit being 42¢ instead of seventy. This
uncertainty about the amount of the ACES tax benefits
exists at the time the non-operators have to vote
"yes" or "no" in the ballot to sanction a new project
or investment, which is exactly the wrong time for
ACES to have uncertainty if it is to attract new
investments here to Alaska. Why? Because the non-
operating working-interest owners have the right to
vote "no" on a ballot to approve a new project, and no
matter now much the operator may support it, if the
project fails to get the requisite number of "yes"
votes, it simply does not proceed. And to stem or
slow the decline in production, Alaska simply cannot
afford to waste even one good investment opportunity
as the result of too much uncertainty about the tax
burden and benefits under such a major tax as ACES.
A solution to these problems would be for the
Department of Revenue to take a different approach
with its regulations from the one it has so far
pursued. Instead of ignoring the joint-interest
billings from operators to the non-operating
interests, the regulations should embrace them as the
starting point for reporting and paying tax. This
would put the tax, in the first instance, on the same
footing as what the non-operators see, also in the
first instance, in their billings from the operator.
The non-operators do not give the operator license to
spend their money without strictly limiting what that
money can be spent for, and the department could
reasonably rely on the non-operators to enforce
discipline on the operator's billings in much the same
way that the department relies on the IRS to audit the
companies federal taxable income, which is the
starting point for Alaska's own corporate income tax.
Such an approach should also avoid most of the
problems that Cherie Nienhuis of the Tax Division
described to you last week about taxpayers reporting
inconsistent data.
We are not suggesting, however, that the department
should rely blindly on the non-operators to audit the
operator's billings. As Ronald Reagan famously said
about dealing with the Soviet Union during the Cold
War, "Trust, but verify." In the case of ACES,
"verify" for the department would mean auditing the
automated system of accounts that each operator has
for recording its expenditures as operator and billing
out those costs to the non-operating participants.
Particular cost codes within such a system of accounts
could be identified by this audit as disallowed kinds
of cost, and by giving notice to the operator and all
the non-operating interests that those cost codes are
disallowed, the department would ensure that all the
participants in a unit or property would be on the
same page with respect to cost codes that are allowed
and billable under their operating agreement but
disallowed for ACES purposes. The department's audits
of individual companies could then be simplified to
verifying that nothing in the disallowed cost codes
was deducted by any of them in their respective ACES
tax returns, thereby conserving audit resources while
ensuring consistency among taxpayers.
At the same time the department could "verify" the
ongoing integrity of each automated system of accounts
by periodically confirming, first, that the software
for that system has not been changed since the
department's last audit of that system, or if changed,
has not been changed incorrectly for ACES purposes.
And if there has been an incorrect change, the depart-
ment would identify the resulting new cost codes that
are disallowed and put all taxpayers in that unit or
field on notice of those changes to the list of
disallowed cost codes.
The Department of Revenue could actually do all these
things without having to change any of the substance
of what it intends to allow or disallow as lease
expenditures in its new regulations. But, to do so,
the department - instead of using the regulations to
define what is or is not allowed - needs to adopt its
concepts of allowed and disallowed costs as audit
standards that it will then apply and enforce in its
audits of automated systems of accounts and software,
as well as in its audits of any claimed lease expen-
ditures for costs that a company may incur in house
that are not billable to others under the applicable
operating agreement.
We have proposed this alternative approach to the
department in each round of public workshops and
hearings on the lease-expenditures regulations. And
in each new draft that came out after a workshop or
hearing, including the regulation that has just been
adopted, this superior alternative was rejected. We
do not know why. But if the Department of Revenue
will not adopt this superior approach voluntarily for
administering ACES, then perhaps one alternative
solution to fix ACES would be to rewrite the tax
statutes so the department has no choice but to use
this clearer and more efficient approach.
9:27:20 AM
Ms. Crockett referred to a slide in a previous meeting
February 17 presentation on Production Tax - Lease
Expenditure Regulations.
9:28:42 AM AT-EASE
9:30:18 AM RECONVENED
Ms. Crockett said the slide contains a quote she made.
Comments from Industry - Slide 27. She continued to read.
This is very different from the picture that the
Department of Revenue pointed for the committee last
week. In fact, they even showed a slide quoting from
a letter I wrote. In the interest of time, I won't
read the entire quote, but this the heart of it:
There is an old quip about never having enough
time to do something right, but always time to do
it over. Here the department has avoided falling
into this quip, which is no small feat and
deserves recognition.
Context is crucial for understanding this statement.
The Declaration of Independence, of instance, says
"all men are created equal." - but this cannot be
taken out of context to day to mean "tough luck for
women." Similarly, in context my statement
specifically addressed some draft regulations about
payments by one field to run its production through
another field's production facilities, and reducing
the owner-field's lease expenditures to the extent
they are offset by the user-field's payments.
My statement about those specific regulations was not
an endorsement of the far broader lease-expenditure
th
regulations that the department adopted January 26,
nor it is an endorsement of the pending
transportation-cost regulations that were unveiled
after I wrote my praise. In fact, it is somewhat
ironic that - from the user-field's perspective - the
department's now adopted lease-expenditure regulations
do not allow the user-field producers to deduct their
full payments to the owner-field, even though the cost
for using the existing facilities is far less than the
alternative of putting in new production facilities.
My comments, from which the quote is taken, urged the
department to allow the user-field to deduct the full
amount of what it pays to the owner-field, which is
the opposite of what the department has done. And it
is also ironic that the regulations I was praising
have not been adopted by the department.
At the present time, however, the bottom line for ACES
is this: even if the tax rate was lowered, ACES is
nowhere close to having the kind of clarity that it
needs to have in order to succeed. And if it does not
succeed, the penalty for all of us - for the state and
the Alaskan public, as well as for our industry - will
be that investments stand to be deferred or perhaps
canceled outright that are urgently needed in order to
offset the relentless decline in production that
steadily goes on as this non-renewable resource is
continuously depleted.
It is for this reason that our industry actually has a
stake in making ACES succeed, rather than watching it
fail. True, the tax rates are too high, and there are
numerous technical problems in ACES that need to be
fixed and many others that should be fixed simply as a
matter of sound tax policy. But despite all these
flaws, and they are serious ones, it is clearly better
to have even a flawed ACES that succeeds in drawing
more investments here, than to have a flawed ACES that
fails to draw them.
At this point I would now like to shift gears and
address several of the inaccurate, incomplete or
misleading statements that this committee heard during
last week's hearings.
One of the most disturbing misconceptions in the whole
public discussion of ACES is the apparently widespread
notion that, by allowing tax deductions and tax
credits in order to attract new investments here, the
state is somehow actually investing in those projects.
This is completely and fundamentally wrong.
The only tax credits that the state is actually
spending money for are the ones that the Oil and Gas
Tax Credit Fund buys from explorers and small pro-
ducers that do not have enough production to incur
ACES tax liability that they could apply their credits
against. This expenditure is incurred because the
state has made the policy choice to do this in order
to attract more independent explorers and small
producers to Alaska. And, for the record, let me say
AOGA supports this goal: Having more companies explor-
ing and producing here is good for our industry, as
well as Alaska.
But the overall tax deductions and credits under ACES
do not inherently share this special attribute of the
subset of tax credits that the Tax Credit Fund
actually buys. Think about it for a second. Suppose
it were true that each dollar of tax benefit from a
deduction or tax credit is literally an expenditure or
investment by the state. What would this imply? Well,
in order to be true, it would mean the state is
legally entitled that dollar instead of the producer -
the state, in other words, literally owns that dollar
and is making an expenditure or investment to the
extent it lets the producer have any part of it.
9:35:40 AM
Ms. Crockett skipped to page 8 to discuss capital spending
and the number of workers on the North Slope.
The next thing I'd like to debunk is the
administration's claim that capital spending and the
number of workers on the North Slope show that ACES is
working just fine. To support this claim, the
Department of Revenue points to North Slope capital
expenditures of $2 billion in 2007 and '08 and $2.2
billion last year, and to an increase in oil and gas
jobs to approximately 12½ thousand in 2008 and '09
from about 11½ thousand in 2007.
The problem with these statistics is this: They do not
distinguish between investment and labor to repair or
replace existing plants and equipment, and investment
or labor for new plants and equipment. Repairing and
replacing existing facilities is very important, of
course, but it is not evidence that ACES is drawing
new investment to Alaska because those activities are
done merely to maintain the status quo. The department
also does not account for projects and investments
that were already under way or committed to before
ACES was passed by the legislature in November 2007
and signed into law that December. And expenditures
and labor to complete such pre-existing commitments
likewise do not show that ACES is drawing new
investment to Alaska.
To indicate how important it is to break down gross
statistics into these individual components, I would
point out that John Mingé, the president of BP
Exploration (Alaska) Inc., told the Meet Alaska
Conference last month, "Our 2010 investment consists
of roughly one-third infrastructure renewal, one-third
for growth and one-third for drilling." Consequently,
the department's raw figures about total capital
spending or the total number of people working on the
North Slope do not show the decline in investment and
work for new projects that has occurred since ACES was
enacted.
But there is clear evidence from the public statements
of individual companies, and even from some of the
administration's own statistics, that things are far
from being as rosy with ACES as the administration is
saying.
9:37:46 AM
Co-Chair Stedman commented that the topic of capital
credits is one the committee struggles with. He requested
clarification of how the credits are used in Prudhoe Bay
and Kuparuk where the "easy oil" is. Ms. Crockett said she
would touch on the amount of in-field drilling taking
place.
9:39:08 AM
Ms. Crockett returned to reading last paragraph on page 8.
Take in-field drilling for example. These wells can be
approved, drilled and go into production in just a
matter of months instead of years, in contrast to
other kinds of investment in field development. As a
result, the statistics about them are much less likely
to be distorted by activities that had already been
committed to before ACES was passed. And we have heard
of members of this legislature telling constituents
that in-field drilling like this has a rate of return
of over 100 percent. Without getting sidetracked about
the assumptions needed to mathematically allow rates
of return to be that high, our reply is that, if in-
field drilling is highly profitable, why did the num-
ber of these in-field wells decrease from 166 wells in
2007 to 153 in 2008 and 147 last year? Putting
rhetoric or political posturing aside, this is the
fact of the matter. And since we have been critical of
the Department of Revenue, we should acknowledge at
this point that the department has disclosed this
decline in its public ACES materials, although its
numbers mistakenly include exploration wells.
The decline in in-field drilling is confirmed by
public statements of the two major operators on the
North Slope, ConocoPhillips and BP. For instance, John
Mingé of BP told the Meet Alaska Conference last month
that his company's "total drilled footage" for in-
field wells "will be more than 50% lower in 2010 vs.
2007" when the figure was nearly one million feet
drilled. He added that BP had "[r]educed our rig count
from 10 to 7 from January last year." And I would
point out that each drilling rig represents about a
quarter of a million man-hours of work a year, or
about 119 full-time equivalent jobs at 2100 hours of
work per year. At that same Meet Alaska Conference
Larry Archibald, the senior vice president of
exploration and business development for the corporate
parent in ConocoPhillips' organization, noted that
industry in the last five years added about 450
million barrel-of-oil-equivalents to reserves for
existing Alaska fields, but "only 35 million since
ACES".
The news is also bad for exploration wells.
ConocoPhillips has been the leading explorer in Alaska
for the last decade and more, focusing especially on
the National Petroleum Reserve - Alaska, or NPR-A for
short. But Helene Harding, who is now interim
president of ConocoPhillips Alaska Inc., warned the
Resource Development Council on November 18 last year
that the number of North Slope exploration wells had
declined from 11 in 2007, to nine in 2008 and eight in
2009, with the figure for 2010 expected to be even
lower. More recently, Mr. Archibald in his remarks
last month at Meet Alaska said ConocoPhillips will not
be drilling any exploration wells in NPR-A this year,
nor was he aware of any other company planning to do
so this year. He noted that "Significant potential
remains in North Slope Giants" but "Giant fields have
worst fiscal terms" under ACES. Perhaps more ominous
is the fact that Mr. Archibald told the conference
that ConocoPhillips in 2009 had relinquished some
880,000 acres of leases that it had in NPR-A.
Now, lest we be accused of being misleading in this
testimony to you, let us be absolutely clear: We do
not claim that every single one of these signs of
deterioration in the situation here has been solely
the result of ACES. But ACES has necessarily been an
economic factor within the overall circumstances
surrounding each one of them. For some it may only
have been a contributing factor, while for others it
may have been decisive. It is even possible that ACES
might not have been a material factor at all, although
we would expect these to be very few in number. Be
that as it may in particular situations, the point we
wish to make is that these facts, taken as a whole, do
provide a clear warning that - contrary to what you
were told last week - ACES is not succeeding in doing
what the Twenty-fifth Legislature was told it would
do.
9:43:26 AM
Ms. Crockett read page 10.
AOGA is reluctant to criticize Gaffney, Cline's
assertion that Alaska as a place to do business should
not be compared to the Gulf of Mexico. This reluctance
is not because AOGA fears they might be correct - to
the contrary, our individual members disagree with
Gaffney, Cline on this and say the Gulf of Mexico is
indeed an appropriate comparison. But, because of
competitive and other reasons, our members cannot
disclose to one another the specific business reasons
that lead individual companies to view the Gulf of
Mexico as an appropriate comparison. So, for now, AOGA
can only say our membership disagrees with Gaffney,
Cline on this point.
One matter that Gaffney, Cline does not seem to have
considered - nor have the administration's in-house
economists - is how a business under ACES could
sustain itself on an ongoing basis in light of the
enormous, front-end-loaded costs it incurs for risky
opportunities and prospects that turn out to be
unsuccessful, sometimes spectacularly so. SOHIO, it
will be recalled, in 1979 and the early 1980s spent
some $2 billion to bid for, and then drill an
exploratory well on, the offshore Mukluk prospect in
the Beaufort Sea, which turned out to be dry.
Industry spent another billion dollars just in bonus
bids for OCS acreage in the Gulf of Alaska offshore
from Alaska's very first oil field at Katalla, which
also turned out dry. The huge sums of money to be able
to make highly risky "bets" like these must come from
somewhere. And that "somewhere" is a company's current
cash flows from its prior gambles that have turned out
to be successful. But, if Alaska is taking 50 or 60
percent or more of the cash flows from current produc-
tion here, where then will companies get the money to
stay in business with the exploration odds already so
stacked against them by Mother Nature?
9:45:17 AM
Ms. Crockett summarized on page 10 and continued on page
11.
In summary, then, ACES is, first of all, a complex and
intricate tax that relies on tax credits and tax
deductions to overcome the adverse effects on
decisions to invest here or not that otherwise would
arise from having such high rates of tax. To succeed
in tilting those decisions toward investment here, the
decision-maker must be confident, when she or he makes
the decision, that the promised tax benefits from the
investment will in fact be realized. This means that
any uncertainty or ambiguity about the amount of tax
owed or the promised tax benefits must be eliminated
as much as possible. Most of the uncertainty and
ambiguity in ACES could be eliminated by the
regulations to implement this tax, but because if its
approach for the administration of this tax, the
Department of Revenue is in the process of adopting
regulations that will actually compound the
uncertainty and ambiguity in ACES, instead eliminating
them.
Second, despite the investment incentives that ACES
could offer with clarifying regulations, it has
overshot the mark in terms of the optimum point where
total state revenues, Alaska jobs and economic growth
are maximized over the remaining life of the fields.
This is because the tax is simply too high.
Third, there are clear, but ominous signs that ACES is
not succeeding in attracting as much new investment as
it is supposed to do. This impending failure is
reflected in the decline in drilling, both for
exploration wells as well as development wells within
existing fields. It is reflected in the relinquishment
of huge amounts of exploration acreage. It is
reflected in the declining amounts being invested for
new projects and development.
In its public presentations about ACES and the future,
ConocoPhillips - using DNR's production forecasts and
extrapolating from published data by the Department of
Revenue about industry expenditures - has identified a
need for more than $40 billion dollars of new
investments for "core fields" to make it through the
next decade and reach the promised land, where Alaska
has a gas pipeline, where the technological challenges
are overcome to produce the billions of barrels of
heavy oil that are already discovered and known to
exist, and where the dream for half a century or more
of production from the North Slope is fulfilled.
Alaska is blessed simply to have the possibility of
such a future. But, to help this future become a
reality, the state must correct the present-day
problems and obstacles being created artificially by
its fiscal regime.
9:47:32 AM
Co-Chair Stedman commented on the differences between the
opinions of industry and the administration on capital
spending projections. The administration maintains that
capital spending looks healthy going forward, yet the
industry is saying that capital spending is distorted
because some of the current projects were underway before
the original PPT. Some of the projects currently on the
books were being reviewed during PPT or ACES; therefore,
there will soon be a precipitous decline. He asked for
clarification of that issue.
Ms. Crockett spoke of a challenge with anti-trust and
competitive issues. She said she cannot analyze or
interpret data from the Department of Revenue because she
does not have access to that information. She maintained
that statements being made about the numbers of workers and
spending being down are accurate.
9:50:21 AM
Senator Thomas asked Ms. Crockett if her concerns about
regulations have been confirmed. Ms. Crockett restated a
concern about the tax rate. She maintained that the "devils
are in the details" regarding ACES. At this point there is
a lot of uncertainty as the industry attempts to comply
with regulations that are still being developed. There is
also concern about future uncertainties.
9:53:52 AM
Senator Thomas wondered if the industry has discussed
moving the company to other countries. Ms. Crockett said
they have not had that discussion. There have been a number
of analyses done.
9:55:38 AM AT-EASE
9:58:12 AM RECONVENED
WENDY KING, VICE PRESIDENT, EXTERNAL AFFAIRS,
CONOCOPHILLIPS ALASKA, referenced a handout entitled,
"Senate Finance Committee, February 23, 2010" (copy on
file). She said she appreciated the opportunity to testify
regarding ConocoPhillips' thinking on ACES production tax
structure and the impact of the total government take. She
reported that there are leading indicators that create
cause for concern: production, wells, exploration activity,
expenditures, jobs, and project activity.
9:59:56 AM
Ms. King showed slide 2, a map of ConocoPhillips' North
Slope Fields. She highlighted fields in which
ConocoPhillips had an interest: Point Thomson, Prudhoe Bay,
Kuparuk, and Western North Slope or Alpine, which abuts the
National Petroleum Reserve of Alaska (NPRA). She defined
"core fields" as Prudhoe Bay, Kuparuk, and Alpine, which
represent about 90 percent of the production on the North
Slope today and into the future. They are legacy projects
which can deliver the production curve referred to during
the various testimonies.
Ms. King said she was asked to discuss the ACES production
tax system. Production tax is only one element of
government take in Alaska. Oil and gas companies are also
subject to royalty, property taxes, state corporate income
taxes, and federal income taxes. All forms of government
take have impacts on the risk/reward balance that investors
look at.
Ms. King noted that she also wished to discuss the total
government take level, which ranges between 65 percent and
75 percent. She gave an example of a project that generates
about $100 in net cash flow, of which only $25 to $35 will
go back to the investors. She recognized that with Alaska's
net tax structure, there is some sharing of the risk and
reward, but maintained that there are uncertainties as to
how a particular investment will translate to the investor
after taxes. She emphasized that Alaska was a high cost
structure. As time progresses, some of the oil is not as
easy to find.
Ms. King turned to the topic of progressivity within ACES.
She defined progressivity - as the price of oil increases
the state's take increases.
10:03:26 AM
Ms. King related what happened to progressivity in 2008.
During a high price environment, on the incremental dollar,
government take can be as high as 80 cents to 90 cents. She
recalled a previous presentation where a representative
from the Department of Revenue indicated there were three
things the state could control with respect to oil and gas
investment, access to acreage, permitting, and taxation.
She voiced concern only with the level of taxation.
Permitting is in the realm of federal jurisdiction.
10:05:04 AM
Co-Chair Hoffman pointed out that, although progressivity
is structured so that the state's take increases as the
price of oil increases, it is also true that the oil
companies have an increase in profit, as well. Ms. King
said that later on in the presentation there was a graph
she could show that would illustrate that point.
Ms. King turned to slide 3 - investment in core fields. It
is the state's forecast for production over time. There is
a lot of uncertainty over future production. She drew
attention to the yellow section, which shows that
production from the core fields may require more than $40
billion of expenditures by the industry during the next
decade. She focused on investments for the next ten years
and how the state and the companies can work together to
generate more production and jobs in the core fields. It
will take a significant investment by the industry.
10:07:14 AM
Ms. King discussed the impact of satellite developments in
Kuparuk and Alpine - slide 4. The North Slope core fields
have declined. She emphasized that there have been
significant investments over the years to mitigate
production decline. She noted that Kuparuk satellites are
currently delivering about 20 percent of the production.
Within the Kuparuk base there has been a combination of
enhanced oil recovery and infield drilling. The company has
made investments in both areas. She emphasized the size of
Kuparuk - about 6 billion barrels of oil in place. Every
one percent recovery equals 60 million barrels. She
maintained that "big fields get bigger" and "you find oil
where you found oil". Kuparuk is a key asset if the right
investment and the right technology advances are made.
10:09:38 AM
Ms. King highlighted production in Alpine, which has been
critical. The satellite production now represents 40 to 50
percent of total production. The base continues to have
infield drilling and oil recovery mechanisms. She pointed
out that future Alpine satellites are within NPRA.
ConocoPhillips is attempting to permit those fields in
order to maintain satellite production.
Ms. King showed slide 5, North Slope remaining barrels. It
shows that core fields are the dominant source of future
state production.
Co-Chair Stedman asked if heavy oils are included. Ms. King
replied that some heavy oil is included. ConocoPhillips is
still reviewing state forecasts.
10:12:24 AM
Ms. King said Point Thomson, Nikaitchuq, Oooguruk and
Liberty are important, but the majority of production is at
core fields. Co-Chair Stedman thought Liberty had
production, but low revenue. Ms. King agreed. She added
that Liberty is not subject to ACES.
Ms. King turned to slide 6 to show that industry drilling
activity is down. It is the first time since 1965 that
ConocoPhillips has not drilled an exploration drill in
Alaska. In 2008 ConocoPhillips invested $500 million for
exploration in the Chukchi Sea, which is in federal waters.
She maintained that exploration dollars are being spent,
but not on state lands.
Ms. King noted that the forecast for 2010 is not certain
because it is not clear which wells will be drilled. She
explained that the graph depicts four exploration wells.
The graph on the right shows a 14 percent decline in
development wells over the last few years.
10:15:26 AM
Co-Chair Stedman pointed out the difficulty of separating
out Kuparuk and Prudhoe from other producing units. He
referred to the left graph and asked how many of the
exploration wells were from Kuparuk and Prudhoe. Ms. King
explained that the left graph would not contain any wells
from Prudhoe and Kuparuk, but rather wells from outside
core producing areas. The graph on the right depicts total
industry wells. She offered to provide information about
drilling activity in the core fields.
10:17:12 AM
Ms. King reported on active drilling rigs in core fields
from 2005 to 2009 - slide 7. The black line is oil price.
The green line is the U.S. oil rig count, which has been
normalized to depict Alaska's environment. She explained
that core field rig trends have remained relatively flat.
The U.S. oil rig count doubled. There are two significant
areas of deviation in Alaska, as compared to other areas.
In 2008 and recently, U.S. oil rig counts increased as oil
prices went up, which did not happen in Alaska. She
concluded that core field drilling activity is not tracking
with oil price. She thought that progressivity was key to
why that was happening. In 2008 ConocoPhillips showed no
impact to net income even though prices were up. She
emphasized the need to look at the balance between risk and
reward. She thought the trend shown on the graph was a
leading indicator of the impact of ACES production tax.
10:21:00 AM
Ms. King talked about the impact of inflation on
expenditures - slide 8. North Slope industry spending on
capital and operating expense is shown. The graph depicts
flat expenditures when adjusted for inflation.
Co-Chair Stedman asked what CERA inflation factors were.
Ms. King said they were used to deflate the investment over
time. Co-Chair Stedman asked if CERA was an international
consulting firm. Ms. King defined CERA as Cambridge Energy
Research Associates, an international consulting firm. She
offered to provide more information.
Ms. King showed slide 9 - extending core field lives. The
graph shows that extending field life is a cause of
spending increases. When looking at core field gross
spending on capital and operating expenses, there is an
increase in maintenance/replacement/repair spending, while
spending on development projects and drilling remains flat.
She emphasized that both categories are equally important.
She offered to update the graph as 2009 data becomes
available.
10:25:33 AM
Co-Chair Stedman asked for a breakdown of
maintenance/replacement/repair spending into operating and
capital credit. Ms. King said she could provide information
about capital expenditures. Co-Chair Stedman commented that
the intent of the 20 percent capital credit was to extract
more oil, not to rebuild the field above ground. Ms. King
replied that she would try to find more data on that
subject. She thought that maintenance/replacement/repair
and development were important for delivering the
production profile.
Co-Chair Stedman thought that differing viewpoints on
capital spending within the basin might be a concern. Lack
of information about maintenance/replacement/repair may
mask production decline. Ms. King explained that much of
capital expenditures are in the category of what's under
development in fields outside of Prudhoe, Kuparuk, and
Alpine. A decline is forecast for expenditures in core
fields, whereas the forecast for production in fields under
development is for an increase.
10:30:15 AM
Ms. King commented on the downward trend in oil and gas
employment - slide 10. The information is from the
Department of Labor. She believed an upward trend began in
2006, followed by a downward trend beginning in July 2009.
State unemployment in the oil and gas support sector is
rising. Production companies, including ConocoPhillips have
experienced a reduction in staffing. She spoke of a leading
indicator - Kuparuk camp usage is down 20 percent.
10:32:28 AM
Ms. King continued with slide 11 - ACES impacting projects.
She listed Oooguruk, Nikaitchuq, and Liberty as examples of
recent project activities that were pre-ACES or not subject
to ACES. She added Point Thomson as another example. Over
$2 billion in projects have been deferred since the onset
of ACES, such as the I-Pad and Gas Partial Processing
projects in Prudhoe, West Sak 1N and 1P, and the ULSD
topping plant. She concluded that there are some projects
moving forward, but often the risk/reward balance does not
justify others.
10:35:19 AM
Ms. King explained slide 12 which shows an example of when
Outer Continental Shelf (OCS) fiscal risk/reward is
balanced. She used a $1 billion investment as an example.
As prices rise, there is a fixed percentage system of
government take. Slide 13 shows the same investment, but
with the Alaska fiscal risk/reward broken.
Senator Egan asked if credits are taken into account. Ms.
King said they were. She explained government take includes
the capital credit expenditure, but not the exploration
credit. She emphasized that there is a lot of risk the
industry takes. This example assumes that there is oil out
there, and there is a 20 percent capital credit. There is
an increase in profit, as shown by the yellow bar. The
percent of government take, the red bar, is substantially
increasing over time. Government take is the combination of
royalty, corporate income tax, property tax, and ACES
production tax. In the third quarter of 2008,
ConocoPhillips' realized oil price for investments in
Alaska was $115, the same as in the fourth quarter of 2009
when the realized oil price was $68. Ms. King related that
the bottom line was that progressivity was playing a big
part. Total taxes going to the state for 2008, other than
income tax, was $3.4 billion.
10:39:46 AM
Ms. King turned to slide 14 - 2010 to 2019 North Slope
production. She said she has tried to depict leading
indicators for discussions concerning ACES production tax.
She dispelled the belief that a 6 percent decline rate was
the state's worst case scenario. She maintained that the
industry has spent billions of dollars in investment during
the decline; ConocoPhillips has invested $40 billion over
the last decade directly into assets, in paying royalty,
and production taxes, and through direct investment. She
emphasized that future production is dependent upon
investment. She attached a 10 to 16 percent decline rate
without well-related activities, maintenance, and other
facility projects.
Ms. King explained that the graph on slide 14 also shows
DOR's forecast at a 2.5 percent decline for 2010 to 2019,
which will require investment, as well. She stressed that
future production is very dependent upon the investment
going forward. The qualified capital expenditure credit
does help the investment profile.
10:42:19 AM
Ms. King concluded with suggestions for improving ACES:
investment in core fields and balanced progressivity. She
mentioned uncertainty about capital credits. She voiced
possible concerns.
Co-Chair Stedman referred to a presentation on heavy oil,
and concerns about a technology gap and high costs. He used
an example of the industry using heavy oil as an increased
cost factor to dilute the effects of progressivity. Ms.
King assured the committee that the industry is looking at
all aspects of the ACES tax structure. She suggested that
the focus should be on adding production and reserves. She
brought up incremental investment and commented that the
company has to look at each one and ascertain how it
affects the industry.
10:46:36 AM
Senator Thomas referred to slide 3. He discussed the merits
of light oil in place of heavy oil. He spoke of potential
methods to raise heavy oil. Ms. King said she represents a
potential shipper. As a shipper looks to an open season,
heavy oil is a factor. Gas is valuable on the North Slope
and is being used every day to help produce more oil. There
is uncertainty of the value of gas in the future. The issue
around oil is that the picture changes every year. There is
a lot of oil to be recovered by using gas over the next ten
years. A balance will need to be found.
10:50:25 AM
Senator Thomas asked about the involvement of feedback from
the industry in correcting ACES. Ms. King talked about
incentivizing new production and more drilling within the
core fields. She spoke of the challenge of figuring out
what constitutes new production. The more total oil going
into the system, the lower the unit cost of oil production.
Both the base and new fields are important. Changes around
progressivity will lead to a discussion with the industry
about future investment. She spoke of a common goal to
generate new production and new jobs.
ADJOURNMENT
The meeting was adjourned at 10:53 AM.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 2010 02 23 ConocoPhillips Testimony SFC by Wendy King.pdf |
SFIN 2/23/2010 9:00:00 AM |
Oil and Gas Production Tax Review |
| 2010 02 23 AOGA Testimony by Marilyn Crockett SFC.pdf |
SFIN 2/23/2010 9:00:00 AM |
Oil and Gas Production Tax Review |
| Agenda 022310 am.docx |
SFIN 2/23/2010 9:00:00 AM |
|
| 2010 03 08 Response Conoco Followup Feb23 SFC.pdf |
SFIN 2/23/2010 9:00:00 AM |
Oil and Gas Production Tax Review |