Legislature(2009 - 2010)BUTROVICH 205

03/11/2009 03:30 PM Senate RESOURCES


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03:38:09 PM Start
03:38:56 PM Overview: Alaska's Oil and Gas Tax Regime
05:15:18 PM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ Overview: Alaska's Oil and Gas Tax Regime TELECONFERENCED
Commissioner Pat Galvin, Dept of Revenue
Rich Ruggiero, Gaffney, Cline & Assoc,
Administration Consultants
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                         March 11, 2009                                                                                         
                           3:38 p.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Lesil McGuire, Co-Chair                                                                                                 
Senator Bill Wielechowski, Co-Chair                                                                                             
Senator Charlie Huggins, Vice Chair                                                                                             
Senator Hollis French                                                                                                           
Senator Bert Stedman                                                                                                            
Senator Gary Stevens                                                                                                            
Senator Thomas Wagoner                                                                                                          
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
All members present                                                                                                             
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
Overview: Alaska's Oil and Gas Tax Regime by Commissioner Pat                                                                   
Galvin, Dept. of Revenue, and Rich Ruggiero, Gaffney, Cline &                                                                   
Assoc., Administration Consultants                                                                                              
     HEARD                                                                                                                      
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
No previous action to consider                                                                                                  
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
COMMISSIONER PAT GALVIN                                                                                                         
Department of Revenue (DOR)                                                                                                     
POSITION STATEMENT: Presented Gas Production Tax Overview.                                                                    
                                                                                                                                
RICH RUGGIERO                                                                                                                   
Gaffney, Cline and Associates, Inc.                                                                                             
Administration Consultants                                                                                                      
POSITION STATEMENT: Presented overview of ACES, Progressivity                                                                 
and Natural gas development.                                                                                                    
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
3:38:09 PM                                                                                                                    
                                                                                                                                
CO-CHAIR  LESIL  MCGUIRE  called the  Senate  Resources  Standing                                                             
Committee meeting  to order at 3:38  p.m. Present at the  call to                                                               
order  were  Senators  French,  Wielechowski,  Wagoner,  Huggins,                                                               
Stedman, Stevens and McGuire.                                                                                                   
                                                                                                                                
^Overview: Alaska's Oil and Gas Tax Regime                                                                                      
           Overview: Alaska's Oil and Gas Tax Regime                                                                        
                                                                                                                              
3:38:56 PM                                                                                                                    
COMMISSIONER PAT  GALVIN, Department of Revenue  (DOR), presented                                                               
the Gas  Production Tax Overview. He  said he would focus  on gas                                                               
issues from  large bodies  of gas  like that  on the  North Slope                                                               
(ANS) and how  the production tax relates to  construction of the                                                               
pipeline.                                                                                                                       
                                                                                                                                
3:39:01 PM                                                                                                                    
COMMISSIONER  GALVIN  said the  purpose  of  the overview  is  to                                                               
demonstrate the legitimacy of the  existing gas fiscal system. It                                                               
is crafted to  protect state revenues and to  incentivize ANS gas                                                               
commercialization by  providing stability for  the state  and all                                                               
the  gas  producers so  they  can  have  the confidence  to  move                                                               
forward. In  addition to  providing that  overview, he  wanted to                                                               
talk  about how  this discussion  will  be ongoing  as they  move                                                               
towards the open seasons associated with the large gas pipeline.                                                                
                                                                                                                                
3:44:09 PM                                                                                                                    
SENATOR STEDMAN said  it appears they have agreed  to disagree on                                                               
the gas  tax as  it sits  today. The  PPT, which  the legislature                                                               
adopted  under   the  previous  administration,  moved   the  gas                                                               
equation  out of  the  oil  tax; ACES  did  the  same thing.  The                                                               
administration had given him the  impression that the gas tax was                                                               
within ACES,  but a lot  of elected officials in  the legislature                                                               
"do not deal it  like that." Since the state had  no gas to sell,                                                               
but  had  the   oil,  lawmakers  "defaulted  out"   the  gas  btu                                                               
equivalency just to  get the issue off the table,  think that gas                                                               
would come  later. He  didn't want  the people  at home  to think                                                               
that  the legislature  has not  signed off  on the  gas structure                                                               
embedded in ACES or the PPT.                                                                                                    
                                                                                                                                
3:46:00 PM                                                                                                                    
COMMISSIONER  GALVIN said  he understood  his  position, but  the                                                               
current system has always been  for both, and it would complicate                                                               
things to separate  them. When the analysis was  done under AGIA,                                                               
it was  found the  current system  was amenable  to a  variety of                                                               
circumstances in the future related to  oil and gas that would be                                                               
favorable to both the state and the producers.                                                                                  
                                                                                                                                
3:48:23 PM                                                                                                                    
SENATOR HUGGINS said he wasn't  prepared to debate the legitimacy                                                               
of the existing system. "Let's  assume it's legitimate." But it's                                                               
kind  of like  a race  car, he  said, and  used a  Nascar analogy                                                               
where the  same car body is  used for several years,  but some of                                                               
the  insides  have been  tweaked.  His  assumption is  that  this                                                               
fiscal regime has some of  those traits that could potentially be                                                               
tweaked,  because they  learn  of  beneficial modifications  over                                                               
time.                                                                                                                           
                                                                                                                                
He wanted to  agree today on the commissioner's  last bullet that                                                               
said  "must continue  discussions."  He  wanted some  agreed-upon                                                               
marks on the timeline from the  2010 open season back to now that                                                               
the legislature could count on  for having discussions and making                                                               
decisions.                                                                                                                      
                                                                                                                                
3:50:13 PM                                                                                                                    
COMMISSIONER GALVIN agreed entirely,  and since TransCanada would                                                               
conclude the  first open  season in July  2010, and  for planning                                                               
purposes if they  were going to entertain changes to  the gas tax                                                               
system prior  to that, they need  to be in place  during the 2010                                                               
legislative  session.  If  the  administration  came  up  with  a                                                               
change, "it would be incumbent on us  to present it to you at the                                                               
beginning  of that  session or  prior  to the  beginning of  that                                                               
session so  that you would  have adequate  time to review  it and                                                               
consider it before passing it during the session."                                                                              
                                                                                                                                
He said  the only  uncertainty is if  something came  to fruition                                                               
before that  from either the  shippers or the state.  However, he                                                               
didn't anticipate that at this  time. The most likely scenario is                                                               
that  they are  before the  legislature at  the beginning  of the                                                               
next regular session to decide on the tax regime.                                                                               
                                                                                                                                
3:52:23 PM                                                                                                                    
Going  back to  the  Nascar  analogy, he  noted  that no  further                                                               
tweaks to the tax regime would  be allowed after the open season.                                                               
They have  to make sure that  decision is made prior  to the open                                                               
season,  and right  now the  administration believes  the current                                                               
system  is  totally  flexible  enough   to  deal  with  potential                                                               
outcomes.  He reiterated  that there  will  be time  in the  next                                                               
session  before  the open  season  to  deal  with this  issue  if                                                               
needed.                                                                                                                         
                                                                                                                                
3:54:04 PM                                                                                                                    
SENATOR WIELECHOWSKI  said he understands that  TransCanada needs                                                               
cost estimates  by January in order  to be prepared for  the open                                                               
season, and asked if that is a factor in his timeframe.                                                                         
3:54:50 PM                                                                                                                    
COMMISSIONER  GALVIN   said  TransCanada  will  most   likely  be                                                               
submitting  its   open  season  applications  to   FERC  in  that                                                               
timeframe, so they  will have to have cost estimates  to do that.                                                               
The  cost  estimates will  provide  the  opportunity if  the  tax                                                               
system is being  discussed at that time, to have  the most up-to-                                                               
date  information.  At  this  point,  the  administration  hadn't                                                               
received  any indication  that the  cost  estimates had  changed,                                                               
although he thought they may be too high.                                                                                       
                                                                                                                                
3:56:33 PM                                                                                                                    
SENATOR WIELECHOWSKI  asked if he  has seen anything  to indicate                                                               
this is not a viable project or less viable than it was.                                                                        
                                                                                                                                
COMMISSIONER  GALVIN replied  no,  because the  economics of  the                                                               
project depend on prices 10 years out.                                                                                          
                                                                                                                                
SENATOR  STEDMAN said  there was  a  lot of  interest in  getting                                                               
better  cost estimates  before getting  into the  tax issue,  but                                                               
it's too  important and complicated  for the legislature  to deal                                                               
with in just 90 days. They  modified the PPT, because it wouldn't                                                               
have been good for the state otherwise.                                                                                         
                                                                                                                                
4:00:29 PM                                                                                                                    
CO-CHAIR  MCGUIRE  added  that her  and  Co-Chair  Wielechowski's                                                               
priority was to  look at a gas tax structure  at the beginning of                                                               
this session,  and she thought the  Interim might be a  good time                                                               
to tackle a  major change to the fiscal system.  Look at what has                                                               
happened in Nenana  and Cook Inlet if you don't  think tweaks are                                                               
needed. The legislature doesn't want to be irresponsible.                                                                       
                                                                                                                                
COMMISSIONER  GALVIN reiterated  that  he  didn't anticipate  the                                                               
need for  an overhaul of  the tax  system before an  open season,                                                               
and new  information would  have to come  forward to  change that                                                               
opinion.                                                                                                                        
                                                                                                                                
4:04:10 PM                                                                                                                    
CO-CHAIR MCGUIRE  asked if she  was correct in thinking  that the                                                               
commissioner thought  it would be  proper to lock-in  the current                                                               
tax structure for 10 years.                                                                                                     
                                                                                                                                
COMMISSIONER GALVIN indicated yes.                                                                                              
                                                                                                                                
4:04:49 PM                                                                                                                    
RICH RUGGIERO,  Gaffney Cline  and Associates,  Inc., Consultants                                                               
for the  Administration, presented  the ACES (Alaska's  Clear and                                                               
Equitable  Share)  progressivity   and  natural  gas  development                                                               
overview. He added  that he didn't think anything  was wrong with                                                               
ACES, especially in  looking at natural gas.  "Just the opposite.                                                               
I  think ACES  and  what  was presented  is  exactly  how it  was                                                               
intended to  work." If  you pick  out one day,  you could  find a                                                               
scenario that  was alarming,  but you have  to remember  that the                                                               
gas pipeline will be 10-plus  years in development, and they hope                                                               
it has 50-plus years of  production. So they are putting together                                                               
systems that act over the long term.                                                                                            
                                                                                                                                
4:06:21 PM                                                                                                                    
He said  Gaffney Cline identified  five key drivers:  fields with                                                               
larger profitability  should be paying more  taxes, investment in                                                               
existing units  should be encouraged,  new investment  outside of                                                               
legacy units  should be encouraged,  and the tax should  be built                                                               
on prior tax  dialogue and the tax must be  durable. They support                                                               
something  that would  encourage  investment in  gas  as well  as                                                               
other  "high-priced" operations  such  as  the unconventional  or                                                               
heavy oil.  They were  clearly looking  at gas  at the  time they                                                               
were giving their input into the development of ACES.                                                                           
                                                                                                                                
MR. RUGGIERO said basically ACES  is a production tax on producer                                                               
non-reinvested cash flow.  He explained that with  oil, you start                                                               
with  a market  price and  deduct transportation,  both TAPS  and                                                               
shipping to  get to  West Coat  markets, to  get the  unit value.                                                               
Then royalty  is deducted.  Then the  producers can  deduct their                                                               
operating  expenses  and  any  and  all  capital  expenses.  This                                                               
produces what  is known as  "producer cash flow."  The production                                                               
tax is calculated  on whatever that cash flow is  on a per barrel                                                               
basis.  That production  tax is  deductible against  owed federal                                                               
and state  income tax. What is  left is what is  called "producer                                                               
profit."                                                                                                                        
                                                                                                                                
Gas works  the same  way, but  instead of  looking at  West Coast                                                               
markets for oil  pricing, it looks at the AECO  Hub, Chicago City                                                               
Gate  or some  other  pricing hub  in the  Lower  48. They  would                                                               
subtract transportation  costs that  would include  pipelines and                                                               
processing facilities to  get the unit value.  Then royalty would                                                               
be  subtracted along  with operating  and  capital expenses,  and                                                               
then the  ACES tax is  calculated. That would leave  the producer                                                               
profit.                                                                                                                         
                                                                                                                                
4:09:13 PM                                                                                                                    
SENATOR FRENCH  asked when  he says "processing"  does he  mean a                                                               
gas conditioning plant on the North Slope.                                                                                      
                                                                                                                                
MR.  RUGGIERO  replied  that  he  is  mainly  talking  about  NGL                                                               
processing,  which  usually  occurs   in  the  midstream  or  the                                                               
downstream sectors.                                                                                                             
                                                                                                                                
SENATOR  FRENCH  recalled  from  a lengthy  period  of  time  the                                                               
legislature spent in  working out the ACES tax that  they put the                                                               
point  of production  for gas  downstream of  a gas  conditioning                                                               
plant on the North Slope.                                                                                                       
                                                                                                                                
MR.  RUGGIERO  responded,  "For  the  purposes  of  ACES,  you're                                                               
correct.  A gas  treatment plant  is downstream  of the  point of                                                               
production,  which means  it is  not deductible  as an  expense."                                                               
Everything upstream  of the point  of production is  considered a                                                               
lease expenditure,  which means it is  deductible. So, downstream                                                               
costs become incremental as opposed to capital costs.                                                                           
                                                                                                                                
He  said that  ACES  is a  combined  tax; so  you  would add  the                                                               
combined oil  and gas  net values  to come  up with  a production                                                               
weighted  average, and  that's the  value upon  which the  actual                                                               
production tax would  be calculated and paid.  The available cash                                                               
flow up  to $30/barrel  is taxed  at a flat  25 percent  base tax                                                               
rate; above  $30, a progressivity  factor kicks in. ACES  has two                                                               
progressivity factors;  the first  one runs from  $30/barrel cash                                                               
flow up to  $92.50/barrel with a rate of .4  percent tax increase                                                               
for every dollar of cash flow above $30.                                                                                        
                                                                                                                                
4:11:31 PM                                                                                                                    
Why was $92.50/barrel picked? It's  because the math shows you'll                                                               
end up right  at 50 percent production tax  at $92.50/barrel cash                                                               
flow.  A second  progressivity  factor of  .1  percent for  every                                                               
$1/barrel of cash flow comes into play above the $92.50.                                                                        
                                                                                                                                
4:12:28 PM                                                                                                                    
SENATOR  FRENCH said  to  plug in  the same  idea  on gas  prices                                                               
requires you  to know what the  current ratio is between  the two                                                               
commodities, and asked what Mr.  Ruggiero considers the base-case                                                               
ratio to be for gas for that progressivity range.                                                                               
                                                                                                                                
MR. RUGGIERO said  he would get into the issue  or gas/oil parity                                                               
later.  He didn't  have that  particular graph,  but he  had some                                                               
slides  that  show what  the  tax  picture  could like  with  the                                                               
combined expected ANS gas production and the oil production.                                                                    
                                                                                                                                
4:13:56 PM                                                                                                                    
MR. RUGGIERO said  if one accepts that thermal parity  is 6:1, if                                                               
he  had a  stand-alone  gas project,  then the  base  rate of  25                                                               
percent  would be  applicable for  cash flow  equal to  $5/mmbtu.                                                               
That  would  be  the  equivalent   of  the  $30  kick-off  point.                                                               
Progressivity would kick in all  the way up to roughly $16/mmbtu,                                                               
which would be plus or minus the equivalent of the $92.50.                                                                      
                                                                                                                                
SENATOR  FRENCH said  that  was helpful,  because  there will  be                                                               
people who  are not combined oil  and gas producers on  the North                                                               
Slope, at least they hope that is the case.                                                                                     
                                                                                                                                
CO-CHAIR MCGUIRE said the thermal  parity discussion is good, and                                                               
she asked him  to reconsider presenting them in  a separate light                                                               
for future considerations.                                                                                                      
                                                                                                                                
4:16:33 PM                                                                                                                    
MR. RUGGIERO  showed a chart of  the distribution of costs  for a                                                               
$75/barrel of ANS oil. After  everything was deducted, $17/barrel                                                               
was left for the producers.                                                                                                     
                                                                                                                                
4:18:12 PM                                                                                                                    
SENATOR HUGGINS  asked what  would happen  to this  percentage if                                                               
the federal government allowed credit for state taxes.                                                                          
                                                                                                                                
MR. RUGGIERO said he hadn't run  that scenario. But, he looked at                                                               
details   of   President  Obama's   2010   budget   that  had   a                                                               
manufacturing credit  of an  estimated $13  billion over  the 10-                                                               
year  planning  horizon.  However,   that  was  not  about  state                                                               
production taxes, but rather a  manufacturing credit for multiple                                                               
industries. The President wanted  to repeal the energy industry's                                                               
eligibility  for that  credit mainly  in refineries  because they                                                               
are so old, and he wanted  to encourage more creation of products                                                               
in the U.S.  The tax in President Obama's plan  that would impact                                                               
the state  is the immediate deductibility  of intangible drilling                                                               
costs, which  would go from  being expensed to  being depreciated                                                               
over a seven-year period.                                                                                                       
                                                                                                                                
SENATOR HUGGINS  said they  know one  thing -  that the  U.S. has                                                               
about $14  trillion in debt,  and the  feds would be  looking for                                                               
revenue.  "I say  to you  there is  an eligibility  factor and  I                                                               
would appreciate  your running the  numbers so we could  see what                                                               
the impact would be."                                                                                                           
                                                                                                                                
MR. RUGGIERO said he would run that.                                                                                            
                                                                                                                                
COMMISSIONER GALVIN  clarified - assuming the  federal government                                                               
doesn't  allow the  companies  to deduct  the  income taxes  from                                                               
their  federal   income  taxes,  what  would   be  the  resulting                                                               
distribution.                                                                                                                   
                                                                                                                                
4:21:17 PM                                                                                                                    
SENATOR STEDMAN asked  him to do a distribution  for other prices                                                               
like down to $50/barrel as well.                                                                                                
                                                                                                                                
COMMISSIONER  GALVIN said  it's important  to get  perspective on                                                               
how ACES works  with regard to high and low  prices; with today's                                                               
prices in  the $40-range  ACES is bringing  in less  revenue than                                                               
the ELF tax  did. So, they have just described  a system that has                                                               
less  government take  at the  low end  - to  keep the  companies                                                               
investing - and more at the high end.                                                                                           
                                                                                                                                
SENATOR STEDMAN said he wanted that quantified.                                                                                 
                                                                                                                                
4:24:00 PM                                                                                                                    
COMMISSIONER  GALVIN said  the cross-over  point between  ELF and                                                               
ACES is $50-$55/barrel.                                                                                                         
                                                                                                                                
4:24:03 PM                                                                                                                    
MR.  RUGGIERO said  one of  the  other topics  they talked  about                                                               
during the  ACES special session  was the issue  between absolute                                                               
rates and marginal rates.                                                                                                       
                                                                                                                                
4:26:21 PM                                                                                                                    
His  graph  showed  the  effect   of  encouraging  investment  by                                                               
indicating what would  happen if an additional  $1/barrel of cash                                                               
flow would  be made as capital  investment in Alaska or  what the                                                               
additional tax would  be if profitability increased  by that same                                                               
amount. Depending on the starting  point, those numbers ranged as                                                               
high as  82 percent.  If you took  the additional  investment tax                                                               
credit of 20  percent, you could get to the  point where both the                                                               
state and the federal governments  were contributing close to the                                                               
full dollar  for every  dollar invested by  the oil  companies if                                                               
they happened  to be averaging  $92.50/barrel of  oil equivalent.                                                               
The  impact of  combining gas  (with less  cash flow  per barrel)                                                               
with the oil (that would have  very high cash flow per barrel) is                                                               
that you  might find  that a  bit of subsidy  is needed  to cause                                                               
that investment to happen.                                                                                                      
                                                                                                                                
MR. RUGGIERO  explained that  part of  putting ACES  together was                                                               
looking  at  the  fact  that other  players  were  developing  in                                                               
existing units  that had  much lower-dollar  value per  unit. The                                                               
one thing they  wanted to make sure  for the state is  that a tax                                                               
regime  did  not  get  put  in  place  that  would  significantly                                                               
discourage investment in those types of operations.                                                                             
                                                                                                                                
They also  did graphs  showing that as  multiple fields  come on,                                                               
the net effective tax rate could  be even lower than the base tax                                                               
rate of  25 percent.  That occurs in  the combining  process when                                                               
moving down  the marginal curve;  the progressivity gives  them a                                                               
slight difference from just straight numerical averaging.                                                                       
                                                                                                                                
4:29:06 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI  asked how  other countries deal  with this                                                               
issue.  Do they  decouple oil  and  gas taxes?  Is our  structure                                                               
similar to other countries'?                                                                                                    
                                                                                                                                
MR. RUGGIERO replied some countries  have the same tax structure;                                                               
some  have different.  Some countries  have "ring  fencing" as  a                                                               
whole  country  (which  in  essence   is  what  ACES  does),  and                                                               
sometimes they  allow ring fencing  by individual field.  In this                                                               
case, oil and  gas might not be able to  be combined because they                                                               
come from  two separate fields.   The UK used to  have a somewhat                                                               
similar production tax, and they used  to ring fence by field; so                                                               
it was kind of hard to offset field A versus field B.                                                                           
                                                                                                                                
CO-CHAIR  WIELECHOWSKI asked  if  Alaska ring  fenced its  legacy                                                               
fields to  encourage production  of fields  and putting  gas into                                                               
the gas pipeline.                                                                                                               
                                                                                                                                
MR.  RUGGIERO  answered  that  the current  system  and  all  its                                                               
incentives  is a  very  workable fiscal  system.  Once you  start                                                               
separating the two, you start  getting into predicting the future                                                               
and having to come up with  fairly strong beliefs in what certain                                                               
parameters will be  cost and revenue wise in order  to set a very                                                               
specific tax structure for a very specific project.                                                                             
                                                                                                                                
CO-CHAIR  WIELECHOWSKI  asked  how   difficult  it  would  be  to                                                               
administer two different accounting systems.                                                                                    
                                                                                                                                
MR. RUGGIERO  said it would  be like opening Pandora's  Box. Some                                                               
people say it  would be pretty simple to do  and there are simple                                                               
ways to  separate gas costs  from oil  costs, but each  and every                                                               
one  of  those simplistic  methods  comes  with  quite a  bit  of                                                               
compromise that would mean either a  gain or a loss for one party                                                               
or the other. Being very exact for  gas or oil uses can create an                                                               
excessive administrative burden.                                                                                                
                                                                                                                                
COMMISSIONER GALVIN added  in the context of  ACES they discussed                                                               
gross tax  versus net. One of  the distinctions that was  made is                                                               
that a gross  tax requires a lot of assumptions  and if those are                                                               
wrong, then the  tax could be wildly off; it  would either under-                                                               
tax or  discourage investment. The  simple way to  administer the                                                               
two taxes would be to  create a formula-based separation of costs                                                               
between  the two  by establishing  a  proxy number  for what  the                                                               
actual costs will be.                                                                                                           
                                                                                                                                
On  the  net-based  side,  he said,  they  were  concerned  about                                                               
creating the ability  to game the system and the  ability to move                                                               
costs around  in order to maximize  revenue to the tax  payer and                                                               
minimize their tax obligations. And  just allowing them to report                                                               
expenses  creates an  accounting  nightmare of  trying to  "chase                                                               
down" whether those costs were properly allocated.                                                                              
                                                                                                                                
4:34:44 PM                                                                                                                    
SENATOR STEDMAN asked  for a list of different  basins around the                                                               
world that  use a combined  oil and  gas tax system  and combined                                                               
with separate progressivities for both oil and gas.                                                                             
                                                                                                                                
MR. RUGGIERO  said he  could do  that, but  they would  also find                                                               
that  some countries  have different  generations of  deals. Even                                                               
some new projects are under  old arrangements. Some countries use                                                               
multiple ways of taxing.                                                                                                        
                                                                                                                                
SENATOR  STEDMAN  said  that  hopefully they  won't  end  up  re-                                                               
debating the gross versus net  since the state has concluded it's                                                               
in the net regime.                                                                                                              
                                                                                                                                
COMMISSIONER GALVIN said he wasn't  insinuating that Alaska go to                                                               
a gross  tax system other  than to say  if you separate  oil from                                                               
gas,  you have  to  come up  with  a way  to  allocate the  costs                                                               
between the two.                                                                                                                
                                                                                                                                
4:36:57 PM                                                                                                                    
MR. RUGGIERO  said in figuring out  how big a subsidy  would have                                                               
to  be in  combining  a  high-cash flow  field  with a  low-value                                                               
field, they need to know the  capital costs of a project going in                                                               
and  compare them  to a  range of  expectations, and  some things                                                               
haven't been considered. For instance,  there may be some loss of                                                               
existing  production by  lowering reservoir  pressure to  produce                                                               
and sell  gas. But,  on the  other hand,  lives of  fields and/or                                                               
facilities may  be extended  by being able  to operate  fields to                                                               
much lower  rates on the  liquids. Also,  people have to  be very                                                               
careful that  they don't look at  a single day or  year snapshots                                                               
to  get a  picture  of exactly  how  ACES would  work  for a  gas                                                               
project, because  they can be  misleading. You have to  look over                                                               
the life  of the project for  an accurate picture, which  is what                                                               
Black and  Veatch did -  and they used  the provisions in  ACES -                                                               
with the same base rates, the  same kick off points, and the same                                                               
progressivity.                                                                                                                  
                                                                                                                                
4:39:58 PM                                                                                                                    
MR.  RUGGIERO said  even  though  he said  they  shouldn't use  a                                                               
single-year  snapshot that  is what  he was  going to  do now.  A                                                               
question came  up about oil/gas  parity and what that  might mean                                                               
to Alaska  gas going down to  the Lower 48. On  average, a barrel                                                               
of oil contains  as much heating value as 6,000/cf  of gas. Since                                                               
each  cf of  gas has  about 1000/btus,  then a  barrel of  oil is                                                               
equivalent  to 6/mmbtus  of  gas. If  gas were  to  be priced  at                                                               
parity, you would take the oil price  and divide it by six. So if                                                               
oil in the  market today was $60/barrel, gas priced  at parity to                                                               
that oil would be $10/mmbtu.                                                                                                    
                                                                                                                                
4:41:24 PM                                                                                                                    
SENATOR FRENCH asked if mmbtu  translates into the valuation they                                                               
are more  commonly used to  using, which is dollars  per thousand                                                               
standard cubic feet.                                                                                                            
                                                                                                                                
MR. RUGGIERO  replied that markets  today are actually  priced in                                                               
dollars  per mmbtu.  FERC has  mandated that  at their  level all                                                               
contracts are  in dollars/mmbtu. The  problem is that gas  in the                                                               
U.S. sells  at anywhere from 900  btu/cf up to 12-1300  btu/cf. A                                                               
lot  of the  early  gaming  in the  system  happened when  people                                                               
priced their  gas on  cf versus mmbtus.  There is  even something                                                               
called "wet"  versus "dry" gas  and high and low  heating values.                                                               
So some  standardization has occurred,  and the prices  they will                                                               
see quoted at different markets around  NYMEX or Henry Hub are in                                                               
dollars/mmbtu.                                                                                                                  
                                                                                                                                
4:42:40 PM                                                                                                                    
CO-CHAIR WIELECHOWSKI  said if the  U.S. adopts the  Kyoto Treaty                                                               
that the carbon  tax would increase the cost of  a barrel of oil,                                                               
which would then increase the ratio.                                                                                            
                                                                                                                                
MR. RUGGIERO responded that thinking  had not been built into his                                                               
presentation today.                                                                                                             
                                                                                                                                
CO-CHAIR WIELECHOWSKI  said he  would be  interested in  seeing a                                                               
model of that possibility.                                                                                                      
                                                                                                                                
COMMISSIONER GALVIN said they had  commissioned Black & Veatch to                                                               
do a  separate study of  looking at various  nation-wide economic                                                               
impacts associated  with the potential  gas line,  which includes                                                               
looking at  issues associated  with supply  and demand.  So, they                                                               
will have information on the potential  impact of a carbon tax on                                                               
both the gas market and the pipeline.                                                                                           
                                                                                                                                
MR. RUGGIERO  added during the  AGIA discussion they  heard about                                                               
Asian LNG pricing at near  parity to oil. Many European long-term                                                               
gas contracts have  oil in the formula that  calculates the price                                                               
of gas at any  time. Some of those are current  as in the current                                                               
gas price based on  current oil; some of those have  as much as a                                                               
three-month lag. But when LNG dried  up coming to the U.S. it was                                                               
because in  those other markets gas  was selling at a  6:1 parity                                                               
basically to the price of oil in those markets.                                                                                 
                                                                                                                                
4:45:26 PM                                                                                                                    
So,  if 6:1  is thermal  parity, gas  has traded  at parity  very                                                               
rarely over the last 14 years.  Parity above 6 could be described                                                               
as gas trading  at a discount to  oil, and work that  was done as                                                               
part of  AGIA suggested they would  see gas trade in  the U.S. at                                                               
an 8:1 ratio instead of 6:1.                                                                                                    
                                                                                                                                
4:47:10 PM                                                                                                                    
SENATOR STEDMAN asked  isn't the LNG market just  evolving into a                                                               
world-wide market and wouldn't that  have an impact on the parity                                                               
issue?                                                                                                                          
                                                                                                                                
MR.  RUGGIERO replied  yes;  the LNG  market used  to  be a  very                                                               
contractual  point-to-point  market   with  very  little  trading                                                               
variability, but  it has developed  over the last few  years into                                                               
much more of an openly  tradable market. The biggest indicator is                                                               
that in 2008  the U.S. had one  quarter of the cargoes  it had in                                                               
the peak  year. The  U.S. is  running on  average 8:1  or 10-11:1                                                               
over the last two years while  Europe and Asia is running at 6:1.                                                               
For  that  kind of  difference,  those  cargoes  will go  to  the                                                               
markets  that  are  paying  the  higher  price.  That  shows  the                                                               
volatility of the market.                                                                                                       
                                                                                                                                
Several  consultants have  said the  U.S.  is going  to become  a                                                               
market  of last  resort and  even given  the economic  conditions                                                               
that exist  today, most  of the pundits  are predicting  an extra                                                               
100 cargoes  coming into the  U.S. Those extra cargoes  this year                                                               
will still  not make 2009  the peak  year for importing  LNG into                                                               
the U.S.                                                                                                                        
                                                                                                                                
SENATOR STEDMAN  said it has been  pointed out in looking  at the                                                               
entire cycle  on the tax  regime that  taxes are calculated  on a                                                               
monthly  basis, and  there may  a string  of several  months that                                                               
would  be  problematic  for  the treasury  because  of  the  wide                                                               
difference in prices of oil and gas.                                                                                            
                                                                                                                                
MR. RUGGIERO said his understanding  is that taxes are calculated                                                               
to pay monthly, but trued up annually.                                                                                          
                                                                                                                                
COMMISSIONER GALVIN  agreed and said  in the end the  question is                                                               
will  they bring  in sufficient  revenue for  what they  intended                                                               
when putting  the tax in  place. It's  important to keep  that in                                                               
mind when looking at these slides.  They need to ask if the total                                                               
context is sustainable or cyclical.                                                                                             
                                                                                                                                
4:52:49 PM                                                                                                                    
SENATOR  STEDMAN said  there is  a reasonable  probability in  20                                                               
years that  will be the  world we're in.  He assured them  that a                                                               
lot of  people would be concerned  with 9-10 months of  a decline                                                               
in gas revenue because of  the progressivity dilution. He doesn't                                                               
want to go  back to the public to say  we're virtually giving our                                                               
gas away - if it's one month or  six months. "We need to fix it."                                                               
This is one of the major issues facing the state.                                                                               
                                                                                                                                
COMMISSIONER GALVIN  agreed that  they need that  discussion, but                                                               
the  question is  that the  state has  to maximize  revenue while                                                               
also maximizing an  incentive for investment. Those  need to stay                                                               
balanced,  and the  current  regime  incentivizes the  investment                                                               
necessary to develop  the gas resource while  providing the state                                                               
with  significant upside  while  recognizing there  will also  be                                                               
instances where  it provides a  benefit to the companies  to have                                                               
the system stable.                                                                                                              
                                                                                                                                
4:55:13 PM                                                                                                                    
MR. RUGGIERO  said that concerns  were raised about  the validity                                                               
of ACES  for long-term gas  development. So, using a  13:1 model,                                                               
he  looked back  14 years  to see  where that  had existed  for a                                                               
period of one month  and found that it had several  times - for a                                                               
total of  six months. The state  never had a year  when that type                                                               
of gas to oil pricing was actually seen.                                                                                        
                                                                                                                                
That brings  them to the  question of  the subsidy, he  said, and                                                               
whether  it's a  smart thing  to combine  the two  in one  fiscal                                                               
regime. So, he put together a  number of charts across a range of                                                               
values.                                                                                                                         
                                                                                                                                
5:00:27 PM                                                                                                                    
SENATOR STEDMAN went back to  slide 15 and said his understanding                                                               
of the model  is that it is extremely simplistic.  He stated that                                                               
more work needs to be done  in advancing this model in complexity                                                               
to get  a better idea  of what they  are dealing with.  He wanted                                                               
more  discussion on  the $100-world  when progressivity  kicks in                                                               
and the 20  percent credit, for instance keeping in  the mind the                                                               
intent is to get more exploration and development.                                                                              
                                                                                                                                
5:03:02 PM                                                                                                                    
SENATOR WAGONER said the independent  explorers and drillers like                                                               
the 20  percent credit. It allows  them to do drilling  that they                                                               
not have been  able to do otherwise when they're  "sitting on top                                                               
of a 50/50 play."                                                                                                               
                                                                                                                                
SENATOR STEDMAN agreed that it  works for the small producers and                                                               
probably the  big producers as well.  The credit alone is  a huge                                                               
incentive.                                                                                                                      
                                                                                                                                
COMMISSIONER  GALVIN agreed,  also saying  the value  of the  tax                                                               
system is in the combination of the two. He elaborated:                                                                         
                                                                                                                                
     But, the  other side is  that it's important  for folks                                                                    
     to  understand  that  it  is   the  same  dynamic  that                                                                    
     provides  what  we  see as  a  valuable  incentive  for                                                                    
     investment in stressed fields,  heavy oil projects that                                                                    
     are  marginal in  terms of  their individual  economics                                                                    
     and providing an incentive for  them to be added to the                                                                    
     stream of  existing production  that causes  the effect                                                                    
     that you  see. If we  showed the effect  of incremental                                                                    
     investment in  a new heavy  oil field, and  adding that                                                                    
     production,  we  could show  it  along  the same  chart                                                                    
     [slide 15]  where you'd  have the  incremental expected                                                                    
     tax on one,  the incremental expected tax  on the other                                                                    
     and  it's  going to  be  more  than what  the  combined                                                                    
     expected tax would  reveal. It's a factor  of the state                                                                    
     choosing   to  create   a   system  that   incentivizes                                                                    
     particular  behavior.  In   this  case  the  particular                                                                    
     behavior  that  we're  trying  to  incentivize  is  the                                                                    
     commercialization  of  our  gas,  and  not  necessarily                                                                    
     maximize   our  recovery   of  taxes   under  the   gas                                                                    
     production scenario.                                                                                                       
                                                                                                                                
5:06:57 PM                                                                                                                    
MR. RUGGIERO  said the system kicked  in the way it  was intended                                                               
when  prices went  up. But  likewise, as  prices have  come down,                                                               
unlike  a  gross tax,  the  tax  has  come  down as  well,  which                                                               
provides help to  the producers to keep what they  have on stream                                                               
and producing.                                                                                                                  
                                                                                                                                
COMMISSIONER  GALVIN said  one of  the  difficulties about  going                                                               
into ACES  was that they changed  the system a very  short period                                                               
of time  after a previous major  change, and that did  impact the                                                               
state's reputation  as a  tax regime in  terms of  stability. For                                                               
that  reason, as  they move  towards  considering other  changes,                                                               
there  is a  certain threshold  of demonstrated  need that  would                                                               
have  to be  met in  order to  justify another  change. "Just  to                                                               
acknowledge  that  we  want  to keep  stability  as  our  overall                                                               
theme."                                                                                                                         
                                                                                                                                
SENATOR  STEDMAN wanted  a 30-second  blurb on  what his  firm is                                                               
doing in response to concerns an LB&A consultant brought up.                                                                    
                                                                                                                                
MR. RUGGIERO said they are building  something that can look at a                                                               
range  of assumptions  so  the  state can  be  prepared when  the                                                               
latest numbers start popping out.                                                                                               
                                                                                                                                
CO-CHAIR MCGUIRE said  this committee would be  interested in any                                                               
information he could share under their agreement.                                                                               
                                                                                                                                
COMMISSIONER GALVIN  commented, "There isn't a  tremendous amount                                                               
of information that's  provided to us that is not  shared." A lot                                                               
of folks  in the energy sector  see a direction towards  gas that                                                               
is  irreversible, and  that will  result  in a  high natural  gas                                                               
price in the  long term. "But it's getting us  from here to there                                                               
that is  expected to take the  significant dip in price  - excess                                                               
supply, use  of storage and those  sorts of things." In  the end,                                                               
he said,  the gasline project  is based on long-term  prices, not                                                               
short term prices.                                                                                                              
                                                                                                                                
5:15:18 PM                                                                                                                    
CO-CHAIR MCGUIRE  thanked them for  their time and  adjourned the                                                               
meeting at 5:15 p.m.                                                                                                            
                                                                                                                                

Document Name Date/Time Subjects
ACES - Riggiero - March 11, 2009.pdf SRES 3/11/2009 3:30:00 PM