Legislature(2013 - 2014)BUTROVICH 205

04/09/2014 08:00 AM Senate RESOURCES


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07:59:23 AM Start
07:59:44 AM SB192
09:03:29 AM Adjourn
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
*+ SB 192 OIL & GAS PRODUCTION TAX RATE/CREDIT TELECONFERENCED
Heard & Held
+ Bills Previously Heard/Scheduled TELECONFERENCED
                    ALASKA STATE LEGISLATURE                                                                                  
              SENATE RESOURCES STANDING COMMITTEE                                                                             
                         April 9, 2014                                                                                          
                           7:59 a.m.                                                                                            
                                                                                                                                
MEMBERS PRESENT                                                                                                               
                                                                                                                                
Senator Cathy Giessel, Chair                                                                                                    
Senator Fred Dyson, Vice Chair                                                                                                  
Senator Peter Micciche                                                                                                          
Senator Click Bishop                                                                                                            
Senator Lesil McGuire                                                                                                           
Senator Anna Fairclough                                                                                                         
Senator Hollis French                                                                                                           
                                                                                                                                
MEMBERS ABSENT                                                                                                                
                                                                                                                                
All members present                                                                                                             
                                                                                                                                
COMMITTEE CALENDAR                                                                                                            
                                                                                                                                
SENATE BILL NO. 192                                                                                                             
"An Act relating to the minimum production tax on oil and gas;                                                                  
and relating to the tax credit applicable to each barrel of                                                                     
certain oil produced north of 68 degrees North latitude."                                                                       
                                                                                                                                
     - HEARD & HELD                                                                                                             
                                                                                                                                
PREVIOUS COMMITTEE ACTION                                                                                                     
                                                                                                                                
BILL: SB 192                                                                                                                  
SHORT TITLE: OIL & GAS PRODUCTION TAX RATE/CREDIT                                                                               
SPONSOR(s): SENATOR(s) STEDMAN                                                                                                  
                                                                                                                                
02/21/14       (S)       READ THE FIRST TIME - REFERRALS                                                                        
02/21/14       (S)       RES, FIN                                                                                               
04/09/14       (S)       RES AT 8:00 AM BUTROVICH 205                                                                           
                                                                                                                                
WITNESS REGISTER                                                                                                              
                                                                                                                                
SENATOR BERT STEDMAN                                                                                                            
Alaska State Legislature                                                                                                        
Juneau, Alaska                                                                                                                  
POSITION STATEMENT: Sponsor of SB 192.                                                                                        
                                                                                                                                
JANAK MAYER, co-founder                                                                                                         
Enalytica                                                                                                                       
POSITION STATEMENT: Delivered a presentation evaluating SB 192.                                                               
                                                                                                                                
                                                                                                                                
ACTION NARRATIVE                                                                                                              
                                                                                                                                
7:59:23 AM                                                                                                                    
CHAIR  CATHY   GIESSEL  called  the  Senate   Resources  Standing                                                             
Committee meeting  to order at 7:59  a.m. Present at the  call to                                                               
order  were   Senators  Bishop,  Fairclough,  Dyson,   and  Chair                                                               
Giessel.                                                                                                                        
                                                                                                                                
          SB 192-OIL & GAS PRODUCTION TAX RATE/CREDIT                                                                       
                                                                                                                                
7:59:44 AM                                                                                                                    
CHAIR GIESSEL  announced the consideration  of SB 192.  She noted                                                               
that Enalytica  would offer input  during the second half  of the                                                               
meeting.                                                                                                                        
                                                                                                                                
8:00:11 AM                                                                                                                    
SENATOR   BERT  STEDMAN,   sponsor  of   SB  192,   Alaska  State                                                               
Legislature, Juneau,  Alaska, stated that  he would first  give a                                                               
broad  history  of  Alaska's  tax structure.  The  theme  of  the                                                               
presentation is to make Alaska  competitive and repeal the going-                                                               
out-of-business sale. He emphasized that  Alaska is not going out                                                               
of  the  oil  business  so  there  is  no  reason  to  give  that                                                               
impression when the state sells its hydrocarbons.                                                                               
                                                                                                                                
8:02:05 AM                                                                                                                    
SENATOR FRENCH joined the committee.                                                                                            
                                                                                                                                
SENATOR STEDMAN  recounted that in  1977 the sovereign  of Alaska                                                               
adopted the  Economic Limit Factor  (ELF) in an effort  to reduce                                                               
severance taxes. In  2006 the ELF was repealed  and replaced with                                                               
the Petroleum Production Tax (PPT),  which was a major shift from                                                               
a tax and royalty system to  a concession contract. He noted that                                                               
the  concession  system  is common  worldwide,  whereas  tax  and                                                               
royalty  is  more a  North  America  system. Alaska's  Clear  and                                                               
Equitable  Share (ACES)  replaced PPT  in 2007  and was  in place                                                               
until  2014 when  it  was  replaced by  Senate  Bill  21. SB  192                                                               
proposes some minor changes to that legislation.                                                                                
                                                                                                                                
8:03:16 AM                                                                                                                    
SENATOR STEDMAN  outlined how the  ELF was applied to  reduce the                                                               
severance tax. The  base severance tax was 15 percent  and then a                                                               
multiplier between 0 and 1  percent was calculated on the average                                                               
of all productivity in a given  field. For example, if the factor                                                               
was .5 percent, the severance  tax would be 7.5 percent. However,                                                               
because the  ELF was  calculated on  volume rather  than dollars,                                                               
the result was that virtually no  tax was applied on 15 operating                                                               
fields.  This put  the state's  fiscal system  completely out  of                                                               
balance.                                                                                                                        
                                                                                                                                
SENATOR STEDMAN said  that to address this  fiscal imbalance, the                                                               
state switched to  a concession contract in 2006.  Under PPT, the                                                               
base tax rate was 22.5 percent  of net value, and a progressivity                                                               
mechanism was added  when the net value was greater  than $40 per                                                               
barrel  (bbl). He  noted that  he and  several other  legislators                                                               
attended classes in  London on fiscal systems  and how sovereigns                                                               
deal with gas  lines and gas contracts.  Those classes reinforced                                                               
the notion that  it's necessary to have a  progressive tax system                                                               
to protect the sovereign. With high  oil or gas prices and profit                                                               
sharing  or concession  contracts,  the sovereign  gets a  little                                                               
larger percentage of the pie.                                                                                                   
                                                                                                                                
8:05:29 AM                                                                                                                    
SENATOR MICCICHE joined the committee.                                                                                          
                                                                                                                                
SENATOR STEDMAN  illustrated the  progressivity factor  under PPT                                                               
using  the example  of $100/bbl  oil with  a net  value of  about                                                               
$70/bbl. Progressivity is ($70 - $40)  X .0025 = 7.5 percent. The                                                               
total tax  rate is 22.5 percent  + 7.5 percent =  30 percent. The                                                               
tax  is  30 percent  X  $70  =  $21/bbl.  He explained  that  the                                                               
problems  with PPT  were that  the deductible  costs were  higher                                                               
than  anticipated,  revenues were  less  than  expected, and  the                                                               
entire process was tainted by the VECO corruption scandal.                                                                      
                                                                                                                                
He  described  ACES, which  is  also  a concession  contract,  as                                                               
similar to  PPT but with  different bells and whistles.  The base                                                               
tax rate  was changed  to 25  percent of net  value and  the .004                                                               
percent progressivity  element was added  when the net  value per                                                               
barrel  was  greater  than  $30.  He  displayed  the  example  of                                                               
$100/bbl oil with a net  value of about $70/bbl. Progressivity is                                                               
($70  - $30)  X .004  =  16 percent.  The  total tax  rate is  25                                                               
percent  + 16  percent =  41 percent.  The production  tax is  41                                                               
percent X $70 = $28.70/bbl. He  noted that the additive on top of                                                               
the base tax increases the percent  share to the sovereign as the                                                               
price moves up.                                                                                                                 
                                                                                                                                
SENATOR STEDMAN  highlighted that  this was  on net  profits, and                                                               
the concern was  that the .004 slope, or  sharing relationship at                                                               
high  oil prices,  was heavily  tilted to  the state.  It took  a                                                               
substantial  majority of  the  upside on  price  shocks from  the                                                               
industry's ability to  participate and gave it  to the sovereign.                                                               
The result was a swelling  of the state's savings accounts. There                                                               
was some discussion  of this during ACES but  his recollection is                                                               
that while  the price  shocks may  have spiked  to $110  or $120,                                                               
they  didn't stay  in  that  arena. He  noted  that the  original                                                               
calculations were  done monthly to grab  those short-term spikes,                                                               
which ended up to be much longer term as is seen today.                                                                         
                                                                                                                                
SENATOR  STEDMAN offered  his perspective  of  the problems  with                                                               
ACES, noting  that probably not  everyone on the  committee would                                                               
agree. First, the progressivity rate  was too high. This resulted                                                               
in  an unfair  split  between  the state  and  industry when  oil                                                               
prices were high, which removed  some industry incentive. Second,                                                               
the credits  were excessive. Industry  got 20 percent  of capital                                                               
costs  deducted against  their taxes.  The  credits were  heavily                                                               
exposed  to  maintenance,  which  came  as  a  surprise  to  some                                                               
legislators. There was  some talk of what it would  take to bring                                                               
back the  old basin but  "we missed it by  a mile," he  said. The                                                               
concern  was   that  too  much   capital  cost  was   going  into                                                               
maintenance  in the  old field,  resulting in  excessive credits,                                                               
which distorted  economic behavior. A number  of legislators felt                                                               
that  the  credits were  so  attractive  that  it would  lead  to                                                               
adverse  decision  making.  Rather  than having  more  oil  wells                                                               
drilled and reworks done, there  was a lot of surface maintenance                                                               
and other things done. Another problem  with ACES was that it was                                                               
too complex.  There were  too many  moving parts  and it  was too                                                               
hard for  the industry to accurately  model investment decisions.                                                               
The  State   of  Alaska   was  in   a  position   of  competitive                                                               
disadvantage compared  to other basins  around the world  when it                                                               
had to  match predictability of  the cash flows and  the modeling                                                               
used to try to attract more capital expenditures.                                                                               
                                                                                                                                
SENATOR STEDMAN  reviewed a list  of the credits under  ACES. The                                                               
capital  credit  was  20  percent.  The  well  lease  expenditure                                                               
credit,  excluding   the  North   Slope,  was  40   percent.  The                                                               
exploration credit  was 20  percent to  40 percent,  depending on                                                               
location. The small producer credit  was $12 million if there was                                                               
sufficient offsetting  income. The loss carry-forward  credit was                                                               
25 percent of the annual loss.                                                                                                  
                                                                                                                                
8:12:00 AM                                                                                                                    
SENATOR STEDMAN  highlighted the  provisions of  SB 21.  The base                                                               
tax is  35 percent of  the net value.  The per barrel  tax credit                                                               
ranges  from $1  to $8,  based on  the Alaska  North Slope  (ANS)                                                               
wellhead value.  He noted  that the  wellhead value  is basically                                                               
the gross stock less royalties  and less transportation down TAPS                                                               
to market.  For the outlying  areas, the gross  revenue exclusion                                                               
for new production is 20 percent  to 30 percent. He noted that SB
192  does   not  address  those   issues.  He  opined   that  the                                                               
monetization of  net operating losses  is fairly standard.  It is                                                               
45 percent  through 2015 and  35 percent thereafter.  The minimum                                                               
tax stays the  same at 4 percent  of gross value at  the point of                                                               
production.  There  is also  a  $12  million small  producer  tax                                                               
credit  that SB  192  does  not address.  He  noted his  personal                                                               
feeling is that this credit is not a problem.                                                                                   
                                                                                                                                
SENATOR STEDMAN outlined  his perception of the  problems with SB
21.  First, the  per  barrel tax  credits are  too  high and  not                                                               
contingent   on  any   performance   measure   such  as   capital                                                               
expenditures. In FY15,  the per barrel tax credits  will cost the                                                               
state almost one  billion dollars. He explained that  he is using                                                               
calculations for next year because FY14  is half ACES and half SB
21. A  second problem with the  current tax system is  that the 4                                                               
percent minimum  tax is  too low.  Under ACES,  the state  took a                                                               
higher percentage at  high oil prices to offset  the exposure the                                                               
state has  at low prices. To  help the industry carry  the burden                                                               
at  low prices  and economic  downturns, the  state was  going to                                                               
take  a higher  percentage  of  price spikes  to  try to  balance                                                               
things  out. He  highlighted  that there  isn't  that ability  in                                                               
current statutes,  but the state's risk  exposure still increases                                                               
as oil  prices drop. Without the  per barrel tax credit,  the tax                                                               
structure would  be regressive.  That means  that the  percent to                                                               
the  sovereign decreases  as  the price  increases.  He said  the                                                               
bottom line is that Alaska's  share of the hydrocarbon value from                                                               
the  legacy fields  is  too  low and  it  has  too much  downside                                                               
exposure.                                                                                                                       
                                                                                                                                
SENATOR  STEDMAN  turned to  SB  192,  explaining that  it  makes                                                               
several basic  changes to Alaska's  petroleum production  tax. It                                                               
cuts the per  barrel credits in half, and raises  the minimum tax                                                               
from 4 percent to  15 percent of the gross value  at the point of                                                               
production. He  described that range  as a place  holder, because                                                               
he didn't  have the data  to accurately  set the trigger  for the                                                               
minimum tax. Acknowledging  that 15 percent is on  the high side,                                                               
he  said it  will  be decreased  to  a point  that  the state  is                                                               
protected  and there's  balance  within the  system. He  stressed                                                               
that physical  stability in the  tax policy is critical  in order                                                               
for  the industry  to  make long-term  decisions.  It works  both                                                               
ways; if  either the  state or  industry has  too heavy  a share,                                                               
there is imbalance.                                                                                                             
                                                                                                                                
He pointed out that as the price  of oil goes down and credits go                                                               
up, the state's  share of its resource wealth  from legacy fields                                                               
is adversely  affected. He  displayed a chart  of the  per barrel                                                               
credits for  SB 21 versus SB  192 at various ANS  wellhead prices                                                               
to show what happens.                                                                                                           
                                                                                                                                
ANS wellhead value                 SB 21          SB 192                                                                  
$140-$150                          $1             $.50                                                                          
$110-$120                          $4             $2                                                                            
$90-$100                           $6             $3                                                                            
Less than $80                      $8             $4                                                                            
                                                                                                                                
Next year  the price  estimate is  about $95,  so at  $6/bbl that                                                               
amounts to roughly  $950 million. He noted that  one concern with                                                               
ACES  was that  there were  too many  credits; they  were in  the                                                               
neighborhood of  $1 billion so  there's the same concern  with SB
21. He suggested that a possible  solution is to set the base tax                                                               
at $45 and raise or lower the per barrel allowance.                                                                             
                                                                                                                                
8:17:46 AM                                                                                                                    
SENATOR MCGUIRE joined the committee.                                                                                           
                                                                                                                                
SENATOR STEDMAN  reminded the committee  that in 2012,  Dr. Pedro                                                               
van  Meurs advised  that, in  his opinion,  legacy fields  should                                                               
have a government  take of 70 percent to 75  percent. Under SB 21                                                               
the government  take is too  low in  the legacy fields,  and that                                                               
impacts the budget and stability of this fiscal system.                                                                         
                                                                                                                                
SENATOR STEDMAN  emphasized the importance  of counting  the cash                                                               
rather  than focusing  on dollars  per barrel.  Prudhoe Bay  is a                                                               
massive old basin  with a lot of in-place  infrastructure that is                                                               
fully depreciated so the margins  are very handsome. He displayed                                                               
a chart  (slide 16)  showing the  cash in  the FY15  forecast. He                                                               
noted that he worked with the  Department of Revenue and that the                                                               
numbers  are a  little different  than in  DOR's Revenue  Sources                                                               
Book. The expectation is that  489,400 barrels per day at $105.06                                                               
yields a gross value of  $19 billion. Subtracting the net royalty                                                               
value of  $2.4 billion and  transportation costs of  $1.6 billion                                                               
yields  the ANS  wellhead  value  of $15  billion.  This is  also                                                               
called  the gross  value at  the  point of  production. From  $15                                                               
billion subtract $2.5 billion in  operating costs (opex) and $4.4                                                               
billion in  capital costs  (capex) and  $315 million  in property                                                               
tax, which  leaves $7.8  billion. The  discussion had  been about                                                               
how  to split  that  up.  It can  be  profit sharing,  concession                                                               
contracts, ACES or PPT,  but in the end it all  comes down to net                                                               
cash, he said.                                                                                                                  
                                                                                                                                
SENATOR STEDMAN  continued to  say that the  35 percent  base tax                                                               
rate (effective tax rate 34.2  percent) would be $2.6 billion and                                                               
the  per barrel  tax credit  is $950  million. The  net base  tax                                                               
would  be about  $1.7 billion,  and then  there's a  $222 million                                                               
loss carry forward credit. This is for the legacy fields only.                                                                  
                                                                                                                                
He  cautioned that  if  oil prices  drop to  the  high $70s,  the                                                               
credits could be $1.250 billion. "And  that's going to be a tough                                                               
one  to explain  in  this  building I  would  think."  This is  a                                                               
dangerous ratchet from the sovereign side, he said.                                                                             
                                                                                                                                
8:24:39 AM                                                                                                                    
SENATOR  STEDMAN   reviewed  the  data  from   North  Dakota  for                                                               
comparison  purposes.  The gross  tax  is  11.5 percent  and  the                                                               
private royalty  owner take  is plus  or minus  20 percent  for a                                                               
31.5 percent gross  tax rate. He noted that in  North Dakota, the                                                               
most common royalty  for the private landowner is  25 percent and                                                               
that's  where  the work  is  taking  place because  North  Dakota                                                               
doesn't  own its  subsurface. Alaska  is  the only  state in  the                                                               
union that owns its subsurface.                                                                                                 
                                                                                                                                
He displayed a  chart that compares the FY15  forecast for Alaska                                                               
versus North Dakota,  applying the same $19  billion gross value.                                                               
Alaska royalties are roughly 12.5  percent and North Dakota is 20                                                               
percent.  The base  tax for  Alaska is  35 percent  on net  ($2.3                                                               
billion) and North Dakota is  11 percent on gross ($3.8 billion).                                                               
Alaska has a per barrel credit  of $953 million, other credits of                                                               
$222 million,  property tax  of $315 million,  and income  tax of                                                               
$447 million.  The total for  Alaska is $4.5 billion  whereas the                                                               
total for  North Dakota  is $6  billion. That  is a  $1.5 billion                                                               
difference. If North  Dakota is the benchmark,  then Alaska isn't                                                               
competitive. He said he would  argue it's a going-out-of-business                                                               
sale. "We should be a lot closer to North Dakota," he asserted.                                                                 
                                                                                                                                
SENATOR  STEDMAN directed  attention  to a  chart titled  "Alaska                                                               
(ACES) vs.  North Dakota and  explained that he applied  the same                                                               
analysis using FY13  historic data. It shows the  Alaska total is                                                               
about $763 million  higher than North Dakota. He  noted that this                                                               
difference is what  generated the discussion that  Alaska was not                                                               
competitive  under   ACES;  progressivity  and  credits   were  a                                                               
problem.  Alaska passed  SB 21  "and North  Dakota is  eating our                                                               
lunch" because  North Dakota  is having  an oil  expansion. Under                                                               
ACES Alaska  was about $.5  billion high, and  under SB 21  it is                                                               
more than $1  billion low. "That's too big of  a spread; we don't                                                               
have to be that aggressive to be competitive."                                                                                  
                                                                                                                                
He   highlighted  the   importance  of   Alaska  receiving   fair                                                               
compensation  for its  hydrocarbons, and  reminded the  committee                                                               
that Alaska's tax  structure is nothing more than  setting a sale                                                               
price for its hydrocarbon. "We could  retitle it and take the tax                                                               
name out of  it. What we're trying  to do is come up  with a fair                                                               
sale price."                                                                                                                    
                                                                                                                                
SENATOR  STEDMAN  said he  didn't  believe  it was  necessary  to                                                               
reduce the  tax in  the legacy  fields to  the level  that's been                                                               
done  in Prudhoe  Bay and  Kuparuk. He  hasn't seen  any analysis                                                               
showing that  a change  of this magnitude  is warranted.  The net                                                               
present value  and internal rate  of return surpass  the industry                                                               
hurdle rate  and are  extremely profitable.  According to  a 2011                                                               
superior court ruling, there are  approximately 7 billion barrels                                                               
of  proven  reserves  that   are  technically,  economically  and                                                               
legally  deliverable  in  the  legacy  fields  with  a  value  of                                                               
approximately $800  billion at current  oil prices. The  value of                                                               
the remaining  reservoir is higher  than the cumulative  value of                                                               
all the North Slope oil produced to date.                                                                                       
                                                                                                                                
He  concluded  that  he  looks   forward  to  engaging  with  the                                                               
committee  on suggested  amendments and  shutting down  the going                                                               
out of business sale, because that isn't going to happen.                                                                       
                                                                                                                                
8:31:58 AM                                                                                                                    
SENATOR  FAIRCLOUGH clarified  that  the TAPS  Committee heard  a                                                               
presentation by  Cathy Foerster yesterday  and she  reported that                                                               
there had  been a  bend on  Prudhoe Bay and  that the  historic 6                                                               
percent decline had been bent up  to 2 percent this year. Kuparuk                                                               
had  been  bent up  from  a  6 percent  decline  to  a 4  percent                                                               
decline.                                                                                                                        
                                                                                                                                
SENATOR FAIRCLOUGH  asked for further  explanation of  the credit                                                               
differences between  the comparison on  FY13 under ACES  and FY15                                                               
under SB 21.                                                                                                                    
                                                                                                                                
SENATOR STEDMAN  replied the only  credits are the  $220 million;                                                               
there are no capital credits.                                                                                                   
                                                                                                                                
SENATOR STEDMAN addressed the first  comment with the explanation                                                               
that  marginal production  is increasing  in the  basin, but  not                                                               
year-on-year. He  said he's been  told the state should  expect a                                                               
future decline curve  for Prudhoe Bay of 1 percent  to 2 percent.                                                               
"We were  talking about that  decline curve  3 years ago  so it's                                                               
nothing  new, although  it's nice  to see  the shallowing  of the                                                               
decline curve and flattening of the tail."                                                                                      
                                                                                                                                
8:35:13 AM                                                                                                                    
SENATOR DYSON expressed interest in  having a discussion on three                                                               
topics: 1)  if the  net tax  leaves room  for opex  to go  way up                                                               
without  providing  an  incentive   for  the  producers  to  find                                                               
cheaper, more  efficient ways  of lifting oil  and getting  it in                                                               
the pipe;  2) if there  is a depletion  allowance; and 3)  if the                                                               
major producers are  going after production in  the legacy fields                                                               
because there is no incentive for heavy oil development.                                                                        
                                                                                                                                
He asked the sponsor to provide his perspective.                                                                                
                                                                                                                                
8:37:45 AM                                                                                                                    
SENATOR  STEDMAN replied  he wasn't  prepared to  speak on  heavy                                                               
oil,  but he  recalled conversations  that the  industry was  not                                                               
ready for incentives  for heavy oil. The legislature  was told to                                                               
wait until the  incentives could be targeted, "so  we're just not                                                               
throwing  credits   on  the  table   and  causing   more  adverse                                                               
behavior."  He noted  that those  conversations took  place under                                                               
ACES and  he hasn't had  further conversations with  the industry                                                               
in the last couple of years.                                                                                                    
                                                                                                                                
SENATOR  MICCICHE said  he had  a number  of questions,  but he'd                                                               
hold them until there was more time.                                                                                            
                                                                                                                                
CHAIR GIESSEL thanked Senator Stedman  and invited Janak Mayer to                                                               
present his evaluation of SB 192.                                                                                               
                                                                                                                                
8:39:43 AM                                                                                                                    
JANAK MAYER, co-founder, Enalytica,  opened his presentation with                                                               
a discussion of the importance of  judging a fiscal system by its                                                               
performance over the life cycle  of an asset versus a single-year                                                               
snapshot.  He  explained that  judging  a  fiscal system  with  a                                                               
single-year snapshot can give an  incomplete or distorted picture                                                               
because  it does  not show  what a  prospective investment  looks                                                               
like under different circumstances.                                                                                             
                                                                                                                                
He displayed  a chart (slide  4) of  the typical cash  flows over                                                               
the  life  cycle of  a  project.  This illustration  shows  heavy                                                               
upfront capital  spending as facilities  are built and  wells are                                                               
drilled. Once  the project  comes on  line, the  capital spending                                                               
generally declines and operating costs  start as revenues come in                                                               
and the  project goes into  operation. When one looks  at project                                                               
economics  and the  attractiveness of  a fiscal  system over  its                                                               
life  cycle, the  focus  is on  this cycle  of  spending and  the                                                               
different components of costs that  appear at different times. If                                                               
one is looking  at single-year snapshots, it is  easy to conclude                                                               
that costs  are going up  and that it takes  more capex to  get a                                                               
barrel of  oil now than  it did a  couple of years  ago. However,                                                               
the general  explanation for  capex is  that there  is additional                                                               
development  spending  going  on  for  several  projects.  It  is                                                               
capital spending for future production  that is being expensed on                                                               
current  barrels. He  emphasized the  importance of  keeping that                                                               
point in mind.                                                                                                                  
                                                                                                                                
8:43:27 AM                                                                                                                    
MR. MAYER displayed a table (slide  5) to show how the production                                                               
tax calculation  compares under  SB 21, under  ACES and  under an                                                               
11.5 percent  gross tax  like in  North Dakota.  The calculations                                                               
are from the Department of  Revenue's [Fall 2013] Revenue Sources                                                               
Book forecast for  2015, but on a dollar per  barrel basis rather                                                               
than  the  total  cash  basis that  Senator  Stedman  showed.  He                                                               
explained that  he did not adjust  for the high royalty  in North                                                               
Dakota because  royalties vary  widely. In part,  this is  due to                                                               
the  great   disparity  in  well   productivity  in   almost  all                                                               
conventional plays.                                                                                                             
                                                                                                                                
The  ANS West  Coast forecast  price  of $105.06  less $10.03  in                                                               
transportation costs  leaves $95.03 in  gross value at  the point                                                               
of  production, in  all  three cases.  The  Revenue Sources  Book                                                               
forecasts  about $46  a barrel  in deductible  expenditures, with                                                               
the   capital  expenditures   close  to   double  the   operating                                                               
expenditures. This was not typical in  the past, but is a sign of                                                               
substantial  new capital  spending  to  create future  production                                                               
that is  expensed over  current barrels. That  is a  basic reason                                                               
why  revenue to  the  state from  the tax  system  over the  next                                                               
couple of  years is  lower than one  might otherwise  have hoped.                                                               
This is not the fundamental  characteristic of SB 21 versus ACES,                                                               
but of profit-based  taxation in general. When  spending is high,                                                               
revenues to  the state are  reduced because costs  are deductible                                                               
against revenues to tax the cash flow.                                                                                          
                                                                                                                                
The production  tax value under  SB 21  is $48.64 and  under ACES                                                               
it's $49.04. It's a little less  under SB 21 because of the $0.40                                                               
per barrel gross  value reduction for that system.  The amount is                                                               
small  because  the  Department  of  Revenue  estimates  it  only                                                               
applies  to  a  small  portion   of  the  total  production.  The                                                               
production tax  before credits is  $17.02 under SB 21,  $16 under                                                               
ACES and $10.93  under the 11.5 percent gross tax.  The amount is                                                               
slightly higher  in the  SB 21  case because  of the  higher base                                                               
rate that  applies. In  the ACES  case there is  a low  base rate                                                               
with progressivity,  but when there  is almost $50 per  barrel in                                                               
costs, there is almost no progressivity trigger.                                                                                
                                                                                                                                
8:48:45 AM                                                                                                                    
MR. MAYER explained that in each  system the credits (in the case                                                               
of ACES  applied on  capital spending  and in the  case of  SB 21                                                               
applied by  some production) primarily  exist to take  what would                                                               
otherwise  be a  slightly regressive  taxation system  and either                                                               
make it flatter  or more progressive. Capital  credits under ACES                                                               
emphasize the cost-progressive nature of  the system so that when                                                               
costs are  very high, taxes are  very low. In this  case, credits                                                               
and  production go  hand in  hand; you  don't have  the situation                                                               
where high  spending on  the low current  production can  yield a                                                               
particularly low tax revenue to the state.                                                                                      
                                                                                                                                
MR. MAYER  advised that looking at  the bottom line in  a single-                                                               
year snapshot  shows very  little difference  between any  of the                                                               
three systems. They  each yield about the same  level of revenue.                                                               
SB 21  yields $10.97,  ACES yields $10.38,  and the  11.5 percent                                                               
gross tax yields $10.93. He  noted that it is somewhat surprising                                                               
that ACES yields the lowest  revenue, considering all that's been                                                               
said.                                                                                                                           
                                                                                                                                
8:50:06 AM                                                                                                                    
MR. MAYER  displayed a  reproduction of  the previous  table, but                                                               
with  a  $15/bbl  assumption  for  capital  spending  instead  of                                                               
$28.08/bbl to  illustrate the  impact this  can have.  This shows                                                               
ACES  as  a very  high-yielding  tax  regime, giving  $20.51  per                                                               
barrel of  production in tax revenue.  SB 21 has a  tax burden of                                                               
$15.55 and the  11.5 percent gross tax remains  at $10.93 because                                                               
it doesn't change  with costs. He said this gives  a sense of the                                                               
impact of  the high capital  spending that's going on  right now.                                                               
It is  fundamentally investment in  future production, but  it is                                                               
bringing down  tax in  terms of the  revenue the  state currently                                                               
receives. He  again stressed that  unless one thinks  about those                                                               
lifecycle impacts  when one  looks at  the snapshot,  one doesn't                                                               
get  a full  picture of  what's going  on and  the nature  of the                                                               
taxation system.                                                                                                                
                                                                                                                                
MR.  MAYER  displayed  a  graph   (slide  7)  that  compares  the                                                               
government take  on base production for  ACES, SB 21, SB  192 and                                                               
SB 21  with the 15 percent  gross minimum proposed in  SB 192. He                                                               
explained that  there are basically  two elements to SB  192: the                                                               
15  percent  gross   minimum  tax,  and  the   reduction  in  the                                                               
production-based  credit. The  idea is  to desegregate  those two                                                               
things and understand the effect of  the change in the credit and                                                               
the effect of the tax.                                                                                                          
                                                                                                                                
He  discussed the  fundamental changes  between ACES  and SB  21.                                                               
There  is the  flat 35  percent tax  rate, but  there are  prices                                                               
above the $65 range that give  a progressive shape to the overall                                                               
curve of the tax. He said  it's important to understand that when                                                               
one  talks about  the effect  of spending  on taxation.  He noted                                                               
that Senator Stedman  did a good job of highlighting  some of the                                                               
problems in ACES  and in particular some of the  problems for the                                                               
state in  times of  low oil  prices or  high spending.  There are                                                               
many ways  (beyond the question  of high  take and its  impact on                                                               
competitiveness) to look at potential  stress cases for the state                                                               
under  ACES and  be  quite  concerned because  of  the very  high                                                               
levels of support for government spending.                                                                                      
                                                                                                                                
That is particularly the case because  ACES, unlike SB 21 or most                                                               
profit base  taxes, didn't  simply say  costs are  deductible and                                                               
the base  is reduced when  you spend more.  It said that  the tax                                                               
rate is  reduced when  you spend more.  The sensitivity  to costs                                                               
and spending,  particularly capital spending, is  high under ACES                                                               
because you  are reducing  the tax base,  changing the  tax rate,                                                               
and introducing the 20 percent capital credit all at once.                                                                      
                                                                                                                                
MR. MAYER explained that SB 21  did some key things to reduce the                                                               
very high  degree of sensitivity  of the tax system  to spending.                                                               
It eliminated  progressivity and the  capital credit and  it made                                                               
the  4  percent   gross  minimum  tax  a  hard   floor  for  base                                                               
production. A  difference between SB 21  and ACES is that  at the                                                               
lowest price  levels ($60 and below  range), SB 21 is  actually a                                                               
tax  increase over  ACES,  primarily because  of  that binding  4                                                               
percent floor.                                                                                                                  
                                                                                                                                
MR. MAYER  said the majority of  the impact of SB  192 comes from                                                               
raising  the gross  minimum tax  from  4 percent  to 15  percent.                                                               
"What it  really does is  it takes  that hockey stick  of whether                                                               
the  regressive  nature of  the  royalty  and the  fixed  minimum                                                               
combined  kick  in to  really  increase  government take  at  the                                                               
lowest prices or the highest  costs and shifts that substantially                                                               
to the  right." Instead of  a point  where taxes are  higher than                                                               
they would  have been under ACES  at $60, the range  is more like                                                               
$75.                                                                                                                            
                                                                                                                                
The  next  slide shows  the  effect  of assuming  higher  capital                                                               
spending.  This is  looking at  a low  capital spending  scenario                                                               
that's  just sufficient  to maintain  the  historical decline  of                                                               
close to 6 percent. But even  in this case there is a substantial                                                               
shift  to the  right  that's a  result of  that  high 15  percent                                                               
floor. The basic  impact of having the capital credit  is to take                                                               
the progressive shape of the  sliding scale credit and flatten it                                                               
out to something more neutral.                                                                                                  
                                                                                                                                
MR MAYER  reminded the committee  that when it considered  SB 21,                                                               
it  was looking  at putting  in a  flat $5  per barrel  credit to                                                               
create a  fairly neutral overall  system. The other body  said it                                                               
would like  to take a little  more on the upside  and was willing                                                               
to give  a little  more on  the downside to  make this  even more                                                               
competitive, particularly  in the $70-$100 price  range. He noted                                                               
that  this is  where  oil  companies did  the  majority of  their                                                               
analysis  of  the  economics, wanting  to  make  it  particularly                                                               
competitive at those  prices and therefore take  slightly more at                                                               
higher  prices. That's  a policy  judgment  that individuals  can                                                               
easily agree to  differ on, but that's the  fundamental impact of                                                               
having  the  credit placed  similarly  to  take that  progressive                                                               
system  and making  it  flatter and  more  neutral. However,  the                                                               
bigger impact is that 15  percent gross minimum; it fundamentally                                                               
changes the economics.                                                                                                          
                                                                                                                                
He displayed  the same  graph comparing  government take  on base                                                               
production in a high  reinvestment scenario, essentially doubling                                                               
the minimum capital spending of  the first series of assumptions,                                                               
everything  shifts to  the  right. You  see  the crossover  point                                                               
where SB  21 is a  tax increase over ACES,  substantially shifted                                                               
to being  more like $95 per  barrel than $60 per  barrel or below                                                               
that we  saw in  the pure minimal  reinvestment. That  rises even                                                               
further to over $100 per barrel in  the case of SB 192, mostly as                                                               
a result of that 15 percent gross minimum tax.                                                                                  
                                                                                                                                
9:00:16 AM                                                                                                                    
MR.  MEYERS advised  that it  is most  important to  consider the                                                               
difference  between progressive  and  regressive fiscal  systems.                                                               
Fundamentally, whether  it's a regressive fixed  percentage gross                                                               
tax or a progressive profit-based  tax, each is very workable and                                                               
each entails a distinct risk-reward tradeoff. He continued:                                                                     
                                                                                                                                
     I can have  a fixed royalty take the  steady portion of                                                                    
     the barrel and  do a great job of  protecting the state                                                                    
     in  the  downside,  because in  any  system  like  that                                                                    
     government take  is very high.  As prices  decrease and                                                                    
     costs increase,  the state is  always protected.  But I                                                                    
     do  that by  striking a  deal that  essentially says  I                                                                    
     want this protection on the  downside so I'm willing to                                                                    
     give up a lot of the upside.                                                                                               
                                                                                                                                
Conversely, one can  do what typical profit-based  tax systems do                                                               
around the world which is to  drive the opposite bargain. That is                                                               
to take more of  the upside and in order to do  that to take more                                                               
of  the risk  on the  downside. From  an investor's  perspective,                                                               
both of those can be  appealing investment scenarios because they                                                               
entail sound risk-reward tradeoffs.                                                                                             
                                                                                                                                
The profit-based  tax in  Alaska under ACES,  and to  some extent                                                               
under SB 21,  has been a hybrid  of those two. It  says the state                                                               
wants at least some of the  upside that comes from a profit-based                                                               
system, but also  some of the protection on the  downside of both                                                               
the  royalty and  the hard  binding 4  percent minimum  floor. It                                                               
provides protection in  the tax system as well  as the protection                                                               
that the  gross royalty  gives. But  to go from  4 percent  to 15                                                               
percent changes that  risk-reward tradeoff. It tries  to get more                                                               
of  the downside  economics  of  a fixed  gross  tax while  still                                                               
trying to take a lot of  the upper end for profit-based taxation.                                                               
He concluded that  it's difficult to have both and  still have an                                                               
attractive investment environment.                                                                                              
                                                                                                                                
CHAIR GIESSEL thanked the sponsor and Mr. Mayer.                                                                                
                                                                                                                                
9:03:29 AM                                                                                                                    
There being  no further  business to  come before  the committee,                                                               
Chair Giessel  adjourned the Senate Resources  Standing Committee                                                               
meeting at 9:03 a.m.                                                                                                            

Document Name Date/Time Subjects
SB 192 vs A.pdf SRES 4/9/2014 8:00:00 AM
SB 192
SB 192 Sponsor Statement.pdf SRES 4/9/2014 8:00:00 AM
SB 192
SB 192 enalytica Analysis 201403.pdf SRES 4/9/2014 8:00:00 AM
SB 192
SB 192 Fiscal Note DOR.pdf SRES 4/9/2014 8:00:00 AM
SB 192
SB 192 SRES Presentation-Senator Stedman 20140409.pdf SRES 4/9/2014 8:00:00 AM
SB 192
SB 192 SRES enalytica 20140409.pdf SRES 4/9/2014 8:00:00 AM
SB 192