Legislature(2007 - 2008)BUTROVICH 205
02/28/2007 03:30 PM Senate RESOURCES
| Audio | Topic |
|---|---|
| Start | |
| SB80 | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| += | SB 80 | TELECONFERENCED | |
ALASKA STATE LEGISLATURE
SENATE RESOURCES STANDING COMMITTEE
February 28, 2007
3:46 p.m.
MEMBERS PRESENT
Senator Charlie Huggins, Chair
Senator Bert Stedman, Vice Chair
Senator Gary Stevens
Senator Lesil McGuire
Senator Bill Wielechowski
Senator Thomas Wagoner
MEMBERS ABSENT
Senator Lyda Green
COMMITTEE CALENDAR
SENATE BILL NO. 80
"An Act relating to allowable lease expenditures for the purpose
of determining the production tax value of oil and gas for the
purposes of the oil and gas production tax; and providing for an
effective date."
HEARD AND HELD
PREVIOUS COMMITTEE ACTION
BILL: SB 80
SHORT TITLE: OIL & GAS PRODUCTION TAX: EXPENDITURES
SPONSOR(s): SENATOR(s) WAGONER
02/09/07 (S) READ THE FIRST TIME - REFERRALS
02/09/07 (S) RES, FIN
02/21/07 (S) RES AT 3:30 PM BUTROVICH 205
02/21/07 (S) Heard & Held
02/21/07 (S) MINUTE(RES)
02/28/07 (S) RES AT 3:30 PM BUTROVICH 205
WITNESS REGISTER
JASON BRUNE, Executive Director
Resource Development Council (RDC)
Anchorage AK
POSITION STATEMENT: Opposed SB 80.
JOHN NORMAN, Chair
Alaska Oil and Gas Association (AOGA)
121 West Fireweed Lane
Anchorage, Alaska 99503
POSITION STATEMENT: Commented on SB 80.
KEVIN BANKS, Acting Director
Division of Oil and Gas
Department of Natural Resources (DNR)
Anchorage AK
POSITION STATEMENT: Answered questions on SB 80.
JONNE SLEMONS, Acting Coordinator
Petroleum Systems Integrity Office (PSIO)
Division of Oil and Gas
Department of Natural Resources (DNR)
Anchorage AK
POSITION STATEMENT: Commented on SB 80.
JOHN IVERSON, Director
Tax Division
Department of Revenue
Anchorage AK
POSITION STATEMENT: Commented on SB 80.
JOHN NORMAN, Chair
Alaska Oil and Gas Conservation Commission (AOGCC)
Anchorage AK
POSITION STATEMENT: Commented on SB 80.
BERNARD HAJNY, Manager
Production Tax and Royalty
BP Exploration Alaska
POSITION STATEMENT: Commented on SB 80.
TOM WILLIAMS, Senior Tax and Royalty Counsel
BP Exploration Alaska
POSITION STATEMENT: Commented on SB 80.
ROBERT MINTZ, Attorney
K&L Gates
Department of Revenue (DOR)
Department of Law (DOL)
POSITION STATEMENT: Commented on SB 80.
ACTION NARRATIVE
CHAIR CHARLIE HUGGINS called the Senate Resources Standing
Committee meeting to order at 3:46:14 PM. Present at the call to
order were Senators Wagoner, Wielechowski, Stedman, Stevens,
McGuire and Huggins.
SB 80-OIL & GAS PRODUCTION TAX: EXPENDITURES
CHAIR HUGGINS announced SB 80 to be up for consideration.
JASON BRUNE, Executive Director, Resource Development Council
(RDC), said he represents diverse resource businesses including
oil, gas, mining, timber companies and more. He said they do not
support SB 80. It is bad public policy and potentially
precedent-setting for other industries around the state.
He said that predictability is important for his members and
this does not allow predictability. He stated:
With the passing of the PPT legislation last year, the
state effectively tripled the production taxes on the
oil industry in Alaska. This likely will result in
over $1 billion in additional revenue to the state
this fiscal year. In passing this legislation, the
producers are now allowed to deduct an operating cost
from these taxes. In addition, they are also allowed
to take a 20 percent tax credit for capital
investments as an incentive for improving North Slope
infrastructure. Further, as statute currently reads,
lease expenditures may not include costs arising from
fraud, wilful misconduct or gross negligence. SB 80
would preclude lease expenditures associated with
improper maintenance of property or equipment.
3:49:45 PM
What exactly is improper maintenance? SB 80 does not
define it. In fact, industry guidelines on maintenance
often change. In many instances, because of new
information, often times this new information is
gleaned from miscues. These miscues do not imply that
the facilities were not properly maintained.
Unfortunately despite the best of intentions,
accidents do happen even with proper maintenance.
MR. BRUNE said he agreed with the AOGCC's letter from Mr. Norman
last week on its concern; one of which is that the definition of
"improper maintenance" is very difficult to find.
Expenses may not include costs arising from gross
negligence. Gross negligence implies a careless
disregard for the consequences of an action or lack of
action. The state already has the protection it needs
and SB 80 is, therefore, unnecessary.
Another large concern SB 80 creates for my members is
the potential for the endless litigation that it
creates. Even if 'improper maintenance' is defined,
our members feel this will just add to the potential
for ongoing disputes between the state and the
producers.
RDC members strive to responsibly develop Alaska's
natural resources. As we strive to do this, I request
you do not move SB 80 out of committee and give last
year's PPT legislation a chance to work before
changing it. Thank you for the opportunity to comment.
3:51:21 PM
SENATOR WAGONER asked if his membership would be in favor of the
State of Alaska allowing expenses incurred by not properly
maintaining a pipeline of this nature. Would they be in favor of
the state giving up $40 million to $116 million, he asked, for
the cost of this project.
MR. BRUNE replied that a process is already in place for
determining gross negligence.
SENATOR WAGONER repeated his question.
MR. BRUNE replied if it is determined as gross negligence.
SENATOR WAGONER stated that there is a difference between gross
negligence and improper maintenance.
3:53:04 PM
SENATOR WIELECHOWSKI asked if the meaning of "improper
maintenance" were changed to "negligently maintained" would that
satisfy some of his concerns.
MR. BRUNE replied that even the American Petroleum Institute has
a difficult time determining what industry standards are for
pipeline and corrosion maintenance. It is a vague term and he
probably wouldn't support it even with that change in verbiage.
SENATOR WIELECHOWSKI asked him if he would support any changes.
MR. BRUNE replied that the PPT bill that passed last year has a
foundation in it that prevents items like this from being
written off and that's what it was intended to do.
SENATOR WAGONER referenced a letter in his file from BP saying
it is going to write off these expenses against the credits of
the PPT bill, and therefore, he didn't think the PPT in its
current form prevented these items from being written off. He
added this is not a tax bill, but an amendment to a tax bill
that clarifies the state did not want to allow these costs.
MR. BRUNE responded:
I think the question is, whether it is improper
maintenance or not, I think... the question needs to
be asked if what transpired last year didn't happen,
and they were just replacing the pipes, would those
expenses be allowed to be written off. If in another
location, pipes that have a history similar to the
ones where we had issues are replaced, are those going
to be allowed to be written off? What is the
definition of when it's appropriate and when it's not?
That's where the predictability is very difficult and
where the certainty isn't there.
SENATOR WAGONER asked if he had an example.
MR. BRUNE replied, "Since PPT just came in to play less than six
months ago, no."
SENATOR WAGONER retorted that Mr. Brune had made reference to
other places where that had happened and the pipe was downsized
and he wanted an instance where that had actually happened.
MR. BRUNE explained, "I was referring to a future potential if
that were to happen. My apologies."
SENATOR WIELECHOWSKI mused that there would be a lot of
disagreement whenever expenditures were calculated and that the
better course might be to go to the gross. He asked if he would
support that.
MR. BRUNE replied that he couldn't say because his diverse
membership has different feelings on that.
CHAIR HUGGINS went to Mr. Banks and asked him to explain the
message in the last paragraph of his February 15 memo that says:
"may also be difficult for agencies to define or establish
improper maintenance or improperly maintained."
3:56:38 PM
KEVIN BANKS, Acting Director, Division of Oil and Gas, said the
memo addressed a couple of things. First, the question of what
they could look at in terms of language like "standard industry
practices" and "improper maintenance." His memo suggested to
Senator Wagoner and the committee that they would look to
practices undertaken by a reasonable and prudent operator under
the same or similar circumstances. Furthermore, "improper
maintenance" might be indicated by an unanticipated failure.
It's not necessarily a failure that would be by itself
- the only evidence you'd want to rely on to indicate
improper maintenance. But you've now got an event
that's caught your attention. Now, the way I see this
bill working is that the Department of Revenue, upon
finding some what an auditor may regard as improper
costs paid to reverse a situation that's caused by
improper maintenance or something like that would come
to the commissioner of Natural Resources for advice.
In that consultative role, I imagine that the
Department of Revenue commissioner could either have
the choice of asking or not - and also has the choice
of taking that advice or not.
The Department of Natural Resources may be in some
position to help make that case, because we will have,
I hope shortly, a fully staffed Petroleum Systems
Integrity Office. And the role that office will have
is to develop, with industry, internal controls and
quality assurance programs for each of the facilities
for the pipeline and so forth. And that means that the
PSIO would review these maintenance and repair
programs that the company has implemented and in a
sense certify, if you will, whether or not those
programs meet industry standards just as we know them
from people like the American Society of Mechanical
Engineers and other third-party certification
organizations.
You may decide whether or not the internal controls
and quality assurance program that is implemented by
the company based on their own experience and their
own familiarity with their equipment is suitable. And
it strikes me that that kind of, if you will,
certification would be evidence of facilities that are
properly maintained in that case, because we would
have determined that the company is doing what it
should as a prudent operator and is formed by the
kinds of standards that may be implemented as part of
their quality assurance program as proper maintenance.
And so costs spent to do that in that sense, I think,
we would be advising to our commissioner, of the
Department of Revenue, in that instance, that those
are costs that would be acceptable.
4:01:49 PM
CHAIR HUGGINS asked if SB 80 was adopted in its present form and
the PSIO matured, what would the cause and effects be to his
organization's operations.
MR. BANKS replied that he didn't think there would necessarily
be conflicts. In its present form, words like "improper
maintenance" would be developed and further defined in
regulation by the Department of Revenue.
Those regulations would conform to a certain degree to
the same kinds of things that our Systems Integrity
Office would be examining. For example, a reliance on
third-party certification organizations or reliance on
terms like 'the prudent operator' in performing
actions in similar circumstances. That basically is
the same kind of measures that our quality assurance
people would be looking to.
CHAIR HUGGINS asked if SB 80 would modify what he is doing or
would he be doing the same thing without it.
MR. BANKS replied he would be doing the same thing without it.
4:04:23 PM
CHAIR HUGGINS said he wrote a note to himself that he had heard
Mr. Banks say he did not want to be a part of determining
standards and measures by going through the process of
developing case law.
MR. BANKS said he couldn't recall making any comment related to
that.
CHAIR HUGGINS asked for his thoughts on how case law might
affect this.
MR. BANKS said he couldn't help him with that.
CHAIR HUGGINS again referenced Mr. Banks memo that stated the
Division of Oil and Gas has no standards currently that would
provide information from which to make a decision on corrosion
and maintenance of the facilities and equipment.
MR. BANKS replied that after discussing this with his staff that
the standards for corrosion control are either in their infancy
or not particularly well-developed at this point. It is his
intention for the PSIO to develop measures for corrosion control
and maintenance - turning to third-party certification
organizations to the extent possible - and relying on the
internal control and recommendations that industry in Alaska may
also be developing for itself.
CHAIR HUGGINS asked Ms. Slemons to comment on how she thought SB
80 would affect her office.
4:06:09 PM
JONNE SLEMONS, Acting Coordinator, Petroleum Systems Integrity
Office (PSIO), Division of Oil and Gas, Department of Natural
Resources (DNR), responded that her assessment of SB 80 is
similar to Mr. Banks'. One of the PSIO's primary functions would
be to assist the Department of Revenue in making a determination
as to whether certain claims should be deducted from taxes. She
would do that by sharing the quality assurance plans already
approved for the various unit operators. It is not a perfect
science. The division would not rely on a single quality
assurance standard, but it would do its best with every
available standard and guideline including the internal
guidelines established by industry looking into the near term,
the mid term and the long term. Carrying out those plans can be
said to be reasonable and prudent. The state would be putting it
on the table in advance; industry would be signing up to do it;
and that's what the office will be inspecting to. Where those
plans are ignored and compliance is an issue, that could be
identified as a case of improper or not maintenance.
CHAIR HUGGINS thanked her and went to a letter from the director
of the Tax Division, John Iverson, and asked him what this last
paragraph meant: "The department supports SB 80 with the caveat
that the bill not limit the department's discretion to deny
deductions or credits under current law."
4:08:19 PM
JOHN IVERSON, Director, Tax Division, Department of Revenue,
replied his concern is that the department has a certain amount
of discretion under standards that are currently in existence in
the PPT statute. For instance, he can deny costs based on the
gross negligence standard, costs that weren't necessary business
expenses and costs that would not be properly billed from an
operator to another working interest owner in the context of a
negotiated unit operating agreement. He did not want this law to
end up confining them only to a standard of improper
maintenance. That is why he suggested to the drafters that the
standard be changed from "relying on" industry standards to
"taking into consideration" - so he has the ability to look at
things other than industry standards on improper maintenance in
case those standards either aren't appropriate or simply don't
apply.
4:10:38 PM
CHAIR HUGGINS asked him to clarify paragraph 4 of the same memo
that says, "The department concern is not with the intent or
necessity of SB 80; it is with implementing the bill."
MR. IVERSON replied:
What I'm getting at there is that if the legislature
deems it's fit to insure that costs for improper
maintenance be excluded from deductibility or from
credit that the legislature needs to pass language
saying so. What I'm saying in that context is that
were we to pass a regulation that expressly
incorporates the language of SB 80, that language
would not find explicit support in the statutory
language and thus be subject to legal challenge. If
the legislature wants to make this more of a bullet-
proof solution, I recommend statutory language or else
we will be arguably subject to a greater legal
challenge after we pass the regulations having this
language.
4:11:53 PM
SENATOR WIELECHOWSKI asked if SB 80 is passed, would the state
be subject to less litigation.
MR. IVERSON replied that he wouldn't go that far. He didn't
think there was a way to get out of litigation over excluding
any of the costs whether gross negligence or improper
maintenance is used.
SENATOR WIELECHOWSKI asked if the state would be avoiding one
layer of litigation.
MR. IVERSON replied that might be closer to what he was getting
at. If the division passes a regulation that explicitly
incorporates the language in SB 80, that regulation itself would
be more easily challenged than if would if it found explicit
support in statute.
CHAIR HUGGINS thanked him and went to Mr. Norman and asked him
to clarify his memo to Senator Wagoner dated February 16.
4:13:26 PM
JOHN NORMAN, Chair, Alaska Oil and Gas Conservation Commission
Association (AOGCC), replied that in that memo he was pointing
out there is no precise definition that would tie "improper
maintenance" to standard practices. "There are some ways we
could get at it, but it is not quite as neat just simply saying
that the practices employed complied with standards. There is no
readily available manual on the shelf."
If the AOGCC were given this task he would probably follow the
lead of the other two agencies that will promulgate some
regulations "to give some specificity to this." He said that
already subsection (6) addresses a disallowance of costs that
might result from wilful misconduct or gross negligence - which
cover the obvious things.
MR. NORMAN said that new subsection (19) - to have any meaning -
has to intend something different than what is already embodied
in (6). So, he would now be looking at something like "ordinary
negligence" or - said differently - "a mistake." He was trying
to point out in his letter that mistakes are made; engineering
isn't a perfect science. He was trying to bring some balance to
the concept as they embark on it.
CHAIR HUGGINS asked him to clarify the first paragraph on the
second page of his memo that says:
Finally, one can never lose sight of the fact that
significant technological advances have occurred as a
result of innovations, which at the time were
departures from standard industry practices.
MR. NORMAN replied that there are numerous examples. One of the
best known is Sir Alexander Fleming experimenting in his
laboratory and letting it get filthy, but in the course of the
experiment, he noticed certain bacteria were being killed in the
Petri dish. It turned out that he had inadvertently discovered
penicillin.
He has heard from the operators that they felt they had the
corrosion situation under control using their additive. Perhaps
they would have set a standard if it had worked, but it didn't.
He didn't know what kind of negligence it could have been.
People have experimented. Some things have worked and some
things haven't. You don't want to make people fearful of trying
things because that's where innovation happens.
4:19:53 PM
CHAIR HUGGINS referenced the second paragraph on the second page
of the same memo that says: "We understand and agree with the
intent of this legislation." However, the last sentence says,
"We do however wish to point out some of the practical
difficulties that may arise in determining whether maintenance
has been proper or improper" and asked him to explain.
MR. NORMAN replied at that time he was speaking as if this bill
passed and the commissioner of DOR had asked for advice on
standards for maintenance. He was trying to figure out how he
would approach that because there often are not any totally
uniformly accepted industry standards that could be used as a
guideline.
He envisioned, in a dispute between the DOR and the taxpayer,
this would call for "frontloading our efforts" because often in
an administrative proceeding you put your evidence into the
record and an administrative law judge will make a decision on
it. Presumably the state would have "to fire its best shot"
upfront if it felt the operator had employed less than standard
practices of the industry. Consequently, the state would not
have the opportunity to later address this issue at the trial,
because there would be no trial.
MR. NORMAN said he didn't want to leave any stone unturned in
efforts to support the DOR if it asks him for advice and advised
We're now down beyond the real easy calls, because I
think they will jump out - they'll be filtered out by
subsection (6) - gross negligence. So we're now down
to the calls about a mistake may have been made here.
Was there a mistake? Yes, there was a mistake made and
now we have to point it out and then presumably if the
taxpayer disputes it, they will come forward with
their expert and say, 'No, based upon what was known
then.'
MR. NORMAN said the date stamping of the decisions and the
state-of-the-art-at-the-time were just some of the practical
difficulties regulations for standards would have to overcome.
If this passed, he would promulgate regulations taking the lead
from other agencies and try to lay a good foundation for
decision making - so it wouldn't be "arbitrary and capricious
decision making." To do that he would start by looking at the
American Petroleum Institute standards, specifications and
recommended guidelines and those of other well-known
professional societies like the National Association of
Corrosion Engineers, the American Institute of Mechanical
Engineers, and other international standards organizations.
MR. NORMAN recalled that Senator McGuire asked if he could adopt
regulations that would give predictability and assurances for
standards of conduct to new investors coming into Alaska. He
remembered his answer was:
No, we will never be able to give 100 percent
assurance of that because it's evolving technology and
it's virtually impossible to anticipate every single
failure that is going to occur and then be able to go
back and to be able to promulgate regulations that
would address that. It often is a learning process.
So my intention in writing this was to indicate we're
ready, we're willing, we're able to work on this. We
do understand the intention of it, but it is not a
simple assignment.
4:25:19 PM
SENATOR MCGUIRE thanked him for looking into that for her and
said it doesn't look like government is doing its job if it
doesn't put together some standards. In law you have rules of
evidence that set out the basis for which evidence can be
offered and accepted in a court room. It allows predictability
for both the defense and the prosecution.
She remembered a time when DNA evidence was a new concept and
very controversial. Often judges would disagree about whether it
would be allowed in or not because it was new science. Whatever
industry you're in you're going to be dealing with new
technology and it just makes sense to have rules or guidelines
by which the state's industries can conduct themselves.
Otherwise the lawyers win.
SENATOR MCGUIRE stated that these businesses are dealing in
nations that have different governments - some are
dictatorships, some are democracies. Democracies should be able
to come up with some level of predictability. She said this
meeting illustrates why a gross tax at a lower rate would have
been the better way to go. The problem is that when you try to
create deductions the idea is to incentivize. But the better way
to do it is through individual legislation, because you end up
"getting wrapped around axel" trying to cover deductions that
would work for everybody.
That's just a little soliloquy, but in the meantime,
your job in this is why you do get paid the big bucks
- and as a lawyer, I think, it is to promulgate a
series of regulations based on what you can do - the
best you can do - based on the American Petroleum
Institute, what other states have done, other
democratic nations have done - and leave a provision
in there for innovation. Innovation, to me, is
different than complete lack of maintenance. If you're
trying at something using a different type of parasite
and it fails, that is dramatically different to me
than sitting back and saying we just won't maintain at
all. And I'm not implying here today, and I've made
this very clear, I'm not implying that anyone ever did
that. But to the extent that there is a simple lack of
maintenance, that is very distinct from maintaining in
a way and using best efforts based on innovation and
technology that you think is moving forward.
MR. NORMAN responded that he understood what she was getting at.
And if this passes, he would promulgate regulations and look at
prevailing generally accepted standards. Senator McGuire put her
finger on a key point, he said, because under a gross tax -
where we are now - you get your slice of the gross no matter
what happens.
He illustrated this concept with an example in which he is the
owner of a mall. The mall has a theatre and he has a profits
lease with it. It says in lieu of a fixed rent he will take a
percentage of the theatre's profits each year. If the theatre
owner hires a kid to run the popcorn machine and he overheats
the machine and starts a fire, ordinarily the mall owner would
look at a number of things. One of them would be the IRS Code
under which the owner of the theatre would be allowed to claim a
deduction for that barring something that was intentionally or
grossly negligent. An experienced employee wouldn't fall in that
category.
Another thing he would look at would be the state corporate
income tax and existing partnership agreements. Most partnership
agreements do not say that the operating partner is liable for
ordinary negligence or making a mistake as opposed to gross
negligence or wilful misconduct.
So gross negligence and wilful misconduct are already
covered under here. So presumably I'm thinking in
terms of ordinary negligence - is the term that I
would use. Because if it's something that goes beyond
that, then it gets already filtered and caught up in
subsection (6) and never filters down to section (19).
But somebody is going to make a decision and say well
this is probably not wilful or gross negligence, but
still something went wrong here and that's where I
envision a question being kicked over to us and then
we would look at it and then we would look to the
standards and have to apply them.
We can pull in a lot of these codes, but the point I
was trying to make is as you pull in these codes, you
may make operators - you may constrain their latitude
to experiment. And that may or may not be good. But
they may think that if we guess wrong and we don't
follow strictly the API standards - these are normally
recommended practices - that there may be a problem
here.
Once we get done with defining as many potential
problems and the codes, and then continually updating
those as those codes are done, we're still going to be
left with a residue of situations that are simply not
defined - that are new situations, a first impression
- and that's where the cases fall back upon the terms
of generally, as I've mentioned, willful misconduct,
gross negligence - or if it's not that, then you look
and say what would a prudent operator do under the
same or similar circumstances. And another standard
that's applied is was the conduct of operations
performed in a 'good and workman-like manner.'
I'll give you a case cited that's interesting because
it's a side-by-side. The federal fourth was asked to
construe a case where there were two side-by-side
agreements and in the one, the operator had the common
clause that said we will not have any liability to our
partners except for gross negligence or wilful
misconduct and at the same time, the partners were
suing that operator for not behaving as a prudent
operator. And the court was able to work through those
and reconcile them and there is some brief discussion
with citations to scholarly articles in the Rocky
Mountain Mineral Law Institute volumes and law review
articles concerning application of these terms.
But I think at the end of the day if we don't define
these standards, we're going to wind up asking
ourselves, 'Was this what a prudent operator would
have done under same or similar circumstances - was it
done in a good and workman-like manner?'
4:36:27 PM
The cite on the case before me - this particular case
is a Utah case, 1990 and the case is Archer v.
Grynberg and that citation for that particular
reference is 738F-Supplement449....
MR. NORMAN said these issues often go to the courts and the
courts have to ask what a prudent operator would do. They work
through an analysis. Another phrase they often use is "in
accordance with good oil field engineering practices." That
would probably be his starting point if he had to find an
operator guilty of waste. He'd ask, "Was this accident an act of
God or did this come about because the operator failed to employ
good oil field engineering practices?" He said he wasn't
necessarily looking in the rear view mirror, but he was thinking
ahead five or ten years to things that haven't gone wrong yet.
SENATOR MCGUIRE said she was thinking that also.
4:38:23 PM
CHAIR HUGGINS said PPT was a net tax and it had multiple pages
of exclusions to include the IRS. He asked if that was accurate.
MR. NORMAN replied that he wasn't thoroughly familiar with the
PPT.
CHAIR HUGGINS said that was fine, but he recalled the ELF was on
the gross and in the end people said it was broken. But just
because it has a title one way or the other doesn't mean one is
successful and the other isn't. He thanked Mr. Norman for his
comments.
4:39:48 PM
MR. NORMAN added one final point. He supported Ms. Slemons'
comments and said that the AOGA is cognizant of the activation
of the PSIO coordinator. He mused that a lot of its assigned
duties would be extremely useful to his office if the two
offices could coordinate, he could avoid having to "staff up" on
some of the disciplines he doesn't currently have.
CHAIR HUGGINS thanked him again and asked BP representatives to
come forward.
BERNARD HAJNY, Manager, Production Tax and Royalty, BP
Exploration Alaska, thanked the committee for being able to
testify on SB 80 and introduced Mr. Brune, Director, Resource
Development Council, and Tom Williams, BP Senior Counsel for Tax
and Royalty in Alaska. He related that Mr. Williams worked for
the state in the years before during and after the construction
of the oil pipeline and the start of oil production on the North
Slope. He was Director of Petroleum Revenue; he is known as the
father of ELF by many and personally wrote nearly all of
Alaska's oil and gas tax regulations and many of the key
statutory provisions of the state's tax laws.
MR. HAJNY said they are tax professionals and would, therefore,
offer their perspective on SB 80 as people charged with
complying with PPT, not on pipeline corrosion, operation or
pigging issues.
4:42:53 PM
TOM WILLIAMS thanked the committee for allowing him to testify.
SENATOR WAGONER stated this bill is about improper maintenance
on an oil line, not about taxes. He thought it would be more
important for the committee to hear from BP about how the
maintenance on this line was handled.
SENATOR McGUIRE interjected that their lawyers wouldn't let them
do that.
MR. WILLIAMS resumed his comments and asked them to look at BP's
presentation. He said the PPT is working for the State of Alaska
and working in three senses of the term.
First, it's working in the sense that the PPT
regulations by the Department of Revenue clarify in
several crucial ways how the pieces of the PPT fit
together. Taxpayers know what is expected of them when
they compute and make their monthly estimated
installment payments and in making the annual true up
on March 31 of the following year. This is a very
complicated tax and it was a lot of work to put the
pieces together.
Second, the PPT is working in the sense of providing a
major increase in state production tax revenue. For
BP, its production tax nearly tripled from about $180
million for the last nine months of last year to over
$500 million for those months. This is fully in line
with the legislature's expectations about the PPT's
revenue effects.
Third, PPT has promised to work in response to the
question on my slide that asks, 'Will Alaska attract
sufficient investment to stem production decline?' The
bulk of the known and likely opportunities in Alaska
for investing in production are concentrated in the
existing fields - that is investing to slow their
decline, to increase the ultimate recovery from them
and to discover ways to develop and produce the 20-
plus billion barrels of heavy and viscous oil that are
known to exist.
4:45:06 PM
The PPT is significantly better suited for this future
than the ELF ever was. In addition, through its credit
for capital expansions, the PPT provides an investment
incentive that was absent from the old ELF-based tax.
Even though the PPT structurally has promise in
attracting the new investment that would be needed to
deal with the threat of declining production, BP
believes the PPT is suboptimal for the state because
the tax rate is too high.
4:46:35 PM
He showed the committee a graph on which Alaska was at the wrong
end of the spectrum relative to other major jurisdictions that
have oil and gas. He continued:
Investments in Alaska have to compete successfully
against opportunities elsewhere and by lowering the
PPT rate, Alaska would increase the competitiveness of
its investment opportunities. The resulting increase
in production will, we are convinced, increase the
total revenues from Alaska's property and income taxes
and royalties by more than any reduction in the PPT.
[Back to the first page of his handout]
SB 80 and the CS for it would introduce unnecessary
uncertainty. We agree with the AOGA testimony given by
Judy Brady last week about the overlap between
existing terms in the PPT and the new standard of
improper maintenance under the bill. I will not repeat
that testimony now. But the issue of improper
maintenance only governs when the provisions of SB 80
would be triggered.
What I'd like to focus on now is what happens under SB
80 after the trigger is pulled. In other words,
imagine a hypothetical future situation that by
definition arises from improper maintenance. If you
look at page 3 of the CS, beginning on line 24, you'll
see subparagraphs....
If you look at beginning at line 24, you'll see three
subparagraphs in paragraph (19) that are designated
(A), (B) and (C). It's these subparagraphs that
specify what happens once the improper maintenance
trigger is pulled. For the moment I'd like to skip
over subparagraph (A) in order to talk about (B) and
(C) because they raise similar questions about sound
tax policy. Then I'll come back to (19)(A), which
presents an entirely different kind of issue.
Subparagraph (19)(B) disallows any cost determined by
the commissioner of revenue to again 'incurred to
maintain the operational capability of facilities or
equipment shut down because of lack of or improper
maintenance of property or equipment;'
The first thing to note is that the disallowance is
not limited to standby costs for keeping up the
operational capability of improperly maintained
property or equipment. Let me say that line again,
because that was an awkward sentence. The stuff that
wasn't properly maintained is not just the subject
here. What is disallowed is the costs of maintaining
shut down facilities or equipment, but the trigger is
the improper maintenance of property or equipment -
not the same term. To the extent they use equipment,
they could overlap, but the different language means
clearly that they are not congruent.
CHAIR HUGGINS asked him for an example.
MR. WILLIAMS responded:
Let's say there's an O-ring that was improperly
maintained and it bursts a leak. In order to be safe,
you have to shut down a whole processing center - a
gathering center. It was the O-ring that was
improperly maintained. This would disallow the costs
of shut down facilities, so it would be the whole
gathering center. And that's the point - is (19)(B)
would permit disallowance of all costs of standing by
and staying ready to resume production, even the
portion for facilities and equipment that were
properly maintained. I don't think that's what you
meant. Certainly, from my point of view, it doesn't
make sense. It penalizes spending money....
SENATOR WAGONER said that was not his intent and that is not
what it says, but he asked him to go on.
MR. WILLIAMS continued:
If I may, through the Chairman, I'd just like to say
that these comments are intended to help.
CHAIR HUGGINS said this is being constructive and they
understand that.
MR. WILLIAMS continued:
All I can say is it says you can't get a deduction if
spend money to maintain operational capability. If it
were up to me, as a former revenue commissioner, I
would want to feel to get back up and running as soon
as possible after a shut down. But, it doesn't seem to
do that.
Subparagraph 19(C) now, similarly disallows costs
determined by the commissioner of revenue to be
'incremental operating expenses incurred as a result
of operating facilities or equipment at diminished
capacity when that diminished capacity is caused by
the lack of or improper maintenance of property or
equipment.'
Here, again, the disallowance is not limited to this
diminished capacity of the property or equipment that
was improperly maintained, but includes diminished
capacity of any operating facilities and equipment.
Again, does this make sense from a tax policy point of
view? I don't think so. (19)(C) is effectively saying
that if it costs more to run a field with diminished
capacity, the state will deter a producer from doing
so by disallowing these costs.
I should think that having a part of the field in
production, even at higher than normal operating costs
is better than having it completely shut down -
especially in light of state royalties and income
taxes which are both enhanced by keeping the field in
production. If anything, (19)(C) should be reducing
the PPT as an incentive for keeping as much of the
field in production as possible, but it does precisely
the opposite instead. Thus, I submit neither (19)(B)
nor (19)(C) is sound tax policy for the state and both
of them should be taken out of the bill.
This gets me back to paragraph (19)(A) on page 3,
lines 24 and 25. Under this subparagraph, any costs
determined by the commissioner of revenue to be
'related to the repair or replacement' of the
improperly maintained property or equipment are
disallowed.
The problem with this new disallowance, from my point
of view, is that it double dips on the flat rate 30
cents a barrel disallowance under paragraph (18). Last
week, Judy Brady explained how this 30 cent
disallowance proposed by Pedro van Meurs was directed
at exactly the same issue that (19)(A) addresses and
how the Senate Special Committee on Natural Gas
Development then rejected a proposal like (19)(A)
twice in favor of the van Meurs' flat-rate
disallowance in paragraph (18). I'll not repeat those
details now.
Even paragraph (18) went too far, in BP's opinion, and
was ill-advised. Other provisions in the PPT law
already address and deal with the questions about
adequate maintenance and they do so in a fair and
reasonable way. If the objective is to make the PPT a
better law for the future, then SB 80 should repeal
paragraph (18). Instead the CS proposes to compound
the error, not only by keeping paragraph (18), but by
adding paragraph (19)(A) to double-dip on the same
costs. This concludes, Mr. Chairman, our testimony on
SB 80 and the committee substitute and I thank you
again for this opportunity to be before you.
SENATOR WIELECHOWSKI asked how much more Alaska would make at
$50/barrel if it charged the world average for its oil.
MR. WILLIAMS replied that he didn't know what the world average
is.
SENATOR WIELECHOWSKI asked if other fees and royalties were paid
to private landowners in Texas and Oklahoma.
MR. WILLIAMS said those are included in his figures.
SENATOR STEDMAN asked if the Gulf of Mexico is on his chart.
MR. WILLIAMS replied yes.
SENATOR MCGUIRE said she understands the ELF was a hybrid and
that Mr. Williams had studied tax systems all over the world
that BP and other companies have entered into agreements on or
been subject to as a result of them existing by dictatorship or
on the statutes in democracies. Her question related to a
statement she made earlier about the ease of taxing the gross
amount and figuring out what deductions the state would like to
give in a more controlled legislative way to offer incentives.
Her concern is that she wants to encourage the companies to
maintain their facilities and operate. She saw good lawyering
going on with his arguments on (B) and (C). She said:
The overall goal is to have safe, good, well-
maintained operations in Alaska. So, if you were king
for the day, what type of a tax system works the best?
And we know we've never seen anything like this. I
mean, that testimony is on the record - and Pedro and
others have said they've never seen anything like this
PPT. Can you answer it?
MR. WILLIAMS answered it's not so much what fits the rest of the
world, but how Alaska wants to manage its resources. He related:
When I was commissioner, the costs of getting the oil
and gas out of the ground were immaterial relative to
the value of the oil and gas and a gross tax made
sense. The reason we put an ELF in was to take
advantage of while it was a very small percentage to
have a very high rate on that oil and gas. But over
time, what's really available in an economic sense is
the margin, you know, after you've got the costs taken
out of getting it out of the ground. That's really
what's available. You can still say, 'Well, we'll tax
on the gross,' but if you do, it threatens to end up
leaving oil and gas production in the ground.
And you can look at the 1977 study that I co-authored.
It's too long to read; it's a couple hundred pages. It
talks about this issue - about a gross tax and its
affect on investment and its affect ultimately on
production and when you push a field across the break-
even point prematurely. And the ELF was the response
of the Department of Revenue then. It's very clear.
I'm not making this up now with 25 years of hind sight
- or 30 years. Heavens! But that system was how it was
designed then.
Obviously, since then there were problems that crept
in with the ELF. Now, which is the worse set of
problems? One of the things that Bernard didn't
mention is that when I was director of the Petroleum
Revenue Division, I got to administer the separate
accounting tax where all these types of deductions
entered into the situation. It was the super tax on
the net and we made it work. I mean it can be done.
And I'm not a rocket scientist. So, I think that there
are rockets scientists now who are working for the
state and advising the state and the administration.
And so I have every confidence that they can look and
see how we made separate accounting work back then;
look and see what the tools are the legislature gave
them in the PPT and make this one work, too. And
structurally for the future where costs are not
immaterial as we look at what are the opportunities -
heavy oil, fields are in decline. Those are challenges
and this is a better suited structure for that type of
future than if you were talking about a brand new
province where you just discovered Prudhoe Bay.
5:00:58 PM
SENATOR MCGUIRE asked if he believed the existing statute that
gives the standard for fraud and gross negligence covers the
hypothetical situation, and the alleged situation of no
maintenance or improper maintenance, that has been described
without adding more clarifying language.
MR. WILLIAMS said he couldn't form an opinion because he didn't
know enough of the facts. Nothing now indicates it was gross
negligence; so BP thinks it is entitled to take a deduction. It
doesn't rise to the level of willful misconduct.
CHAIR HUGGINS asked him to think about SB 80's retroactive date
back to April 2006 and how it relates to ex post facto and
federal laws.
5:03:13 PM
SENATOR WAGONER stated that it looks like they are letting
themselves be dragged back into a debate on PPT and not just
this amendment to it. He reminded them that PPT, boiled down to
its lowest concept, was credits for exploration and new
production.
We never intended - through PPT - there was never
discussion on the PPT legislation - and I sat through
most of it and I know Senator Stedman did. You sat
through a lot of it - never anything discussed or
brought to the committee about a maintenance item of
this size and of this expense. Just to add one other
thing. We've all got a letter from Don Bullock
addressing your question and I've already read that.
SENATOR STEDMAN mentioned that at some point he wanted to talk
about Pedro van Meurs' consultation with the administration and
the legislature in dealing with this aging field and the
potential costs of up to $2 billion in infrastructure
improvements and the effect the PPT would have on that as far as
potentially putting the state at a disadvantage if PPT wasn't
modified to disallow the 30 cents.
CHAIR HUGGINS said he understood that and they would have that
discussion on another day.
MR. WILLIAMS replied that ex post facto laws are prohibited
under the federal constitution, as well as the state
constitution. An ex post facto law is a law that changes the
legal effect of an action or an omission. Sometimes in a
criminal context, it means the sentence or fine is changed after
the act. Usually it means a specific fact, act, omission or
person is in mind. The closer to the action, the easier it is
for an ex post facto law to be found.
The question of due process is raised in making an act
retroactive. If a law is made retroactive to an earlier date in
the same year, that doesn't offend due process. If it's a
general law, like the PPT that didn't have any specific person
or event in mind - that's when due process principles would
apply. The farther back in time you go with legislation, the
higher the risk can become of having a due process issue. He
summarized that an ex post facto law is about specifying who or
what you are trying to change the rule on.
5:07:58 PM
CHAIR HUGGINS asked if SB 80 is a violation of ex post facto
law.
MR. WILLIAMS replied that he thought there was a serious risk
that it is an ex post facto law.
CHAIR HUGGINS asked Mr. Mintz's opinion.
ROBERT MINTZ, attorney with K&L Gates, said he is working with
the Department of Law and the Department of Revenue on
production tax matters. His understanding of the constitutional
prohibition of ex post facto laws is that they are limited to
criminal penalties and don't apply to civil law. He agreed with
Mr. Williams that due process is a civil law issue.
He stated no law absolutely prohibits retroactive changes.
Retroactive changes to taxes, in particular, have generally been
upheld in court. Courts have said as long as you don't go too
far in the past that there is no due process problem, but he
didn't know how far back you could go. He thought it more likely
that the change discussed in SB 80, if enacted now, would be
upheld. However, he said:
Mr. Williams, I think, was also kind of focusing on a
slightly different issue, but - which might also have
due process ramifications. And that is when the
legislature makes such a change, are you really
focusing on a particular event, a particular
individual entity, and that could be somewhat
problematic.
I wouldn't view it that way. Firstly, what I think it
was Senator Stedman a few minutes ago explained that
when the legislature was looking at issues such as
gross negligence, what costs would be deductible under
the new law. It hadn't necessarily focused on the
question of the major cause of an event that might be
due to some sort of failure to observe industry
practices. So, I think that the legislature should be
cautious about making changes in the law, particularly
retroactive changes that are targeted at a particular
entity or a particular event, but I wouldn't view it
that way here. To me it seems that basically the
legislature has become more educated about some of the
issues and some of the factual situations that might
arise under the law and there may be a gap in the way
that the current law deals with some situations - or
there may be policy questions that were not clearly
before the legislature's - that the legislature hadn't
focused on when it was originally considering the
legislation. And from that standpoint, it's perfectly
legitimate to become informed based on more recent
events and for the legislature to consider what the
appropriate policy is based on the additional
information.
5:12:49 PM
SENATOR WAGNER read a memo from Don Bullock, legislative
counsel, dated February 26, 2007, into the record as follows:
'You asked whether enactment of SB 80 would violate
the prohibition against ex post facto laws in the
United State and Alaska Constitutions because of the
disallowance of certain deductions applied
retrospectively to April 1, 2006, the effective date
of the PPT.' And then he said, 'The answer is no.'
5:13:31 PM
SENATOR MCGUIRE added for clarification that the committee is
discussing the specific case of BP only because it has been
described or alleged in the news. But what the committee is
generally discussing is what would happen to any company that
failed to maintain, properly or at all, any line.
So, to be clear, I don't regard this bill as a
specific response to a specific situation, but rather
a recognition that an allegation, if true, could occur
in the future - might have occurred - and we should
address it.
5:14:36 PM
CHAIR HUGGINS said:
I do not want to allow the people of Alaska to be
exploited. My take is much different than yours. I've
got to say that in all candor. I mean I think this is
event-driven. My good friend, Meryl, there - we were
talking about it today - about BP - and, you know,
taking the citizens of Alaska based on the event that
happened. So I just had to say that in all candor.
That's my take on it. It's different and that's just
the way it is.
SENATOR MCGUIRE responded that it certainly got the conversation
going.
There being no further business to come before the committee,
the chair adjourned the meeting at 5:15:15 PM.
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