HOUSE BILL NO. 61 "An Act establishing an exploration and development incentive tax credit for persons engaged in the exploration for and development of less than 150 barrels of oil or of gas for sale and delivery without reference to volume from a lease or property in the state; and providing for an effective date." Representative Chenault MOVED to ADOPT Committee Substitute, Work Draft 23-LS0270\Q (4/15). There being NO OBJECTION it was so ordered. REPRESENTATIVE MIKE CHENAULT, SPONSOR, provided information about the bill. He read from a shortened Sponsor Statement as follows: HR 61 creates a new income tax credit to encourage increased exploration and development of natural gas reserves south of the Brook Range. To qualify for the credit, operators must successfully drill and develop reserves that produce natural gas for sale and delivery. This is a successful efforts bill, which means that no credits will be given for dry holes or for exploration that is not developed. Currently, the Cook Inlet continues to have great potential for additional natural gas development Other Alaska basins outside of the North Slope have similar potential. However, the combination of exploration risk, high development costs and historic low natural gas prices has created a disincentive to drill for new reserves as compared to other areas of the world. By providing a credit for successful efforts, more exploration will occur in Southern Alaska leading to much needed new natural gas reserves. This will benefit all residents and businesses at no direct cost to the state. In addition to the benefit of developing new gas reserves, increased Cook Inlet drilling will also aid the general economic status on the Kenai Peninsula and in Anchorage as well as other areas of Alaska. Moreover, increased tax revenue from additional hydrocarbon production will more than offset any fiscal impact from the proposed credit. JOHN A. BARNES, ALASKA BUSINESS UNIT MANAGER, MARATHON OIL Discussed slides from a power point presentation as follows: HB 61 - What does it Do? •Draws more E&P Investments to Alaska •Creates income tax credit to encourage exploration and development of gas reserves south of Brooks Range •Primary focus is on Cook Inlet, but applies to other Alaska basins •Focus is on natural gas. •Levels the playing field somewhat with other exploration opportunities around the world. HB 61 - How Does it Work? •Applies to 10% of Qualified Capital Investment •Applies to 10% of Qualified Expense •May offset no more than 50% of corporate income tax in any one year (up to five additional years) •Only applies to successful efforts. •Incentive can be factored into project economics. HB 61 - Why is it needed? •Currently there is not enough Alaska E&P Activity •Natural Gas Reserves have been and are continuing to decline in the Cook Inlet. -Current Cook Inlet proven natural gas reserves are estimated at 2 TCF •(Based on DNR DOG 2002 report, less 2002 production) •Despite recent increase in Cook Inlet exploration activity, reserves are not being replaced on an annual basis •Cook Inlet deliverability has declined over last several years. Mr. Barnes referred to a graph illustrating the relationship between Cook Inlet supply and demand (copy on file). •Supply and demand rationalization is occurring. -Not enough gas to feed low price consumer. -Gas price increasing •Enstar average gas cost (WACOG) $2.55/mcf •Most recent Enstar contract gas price $2.75 to Henry Hub •Henry Hub recently over $9.00/mcf Cook Inlet Reserves & Resources •Current proven reserves - 2000 BCF -Approximately 10 year production life, assuming no decline. •Potential Gas Committee Resource Estimates -Probable Reserves - 1050 BCF -Possible Reserves - 2100 BCF Impacts to the State of Alaska •Stimulates Cook Inlet, and potentially other basin exploration. •Aids in maintaining Cook Inlet 200+ BCF/year production. th -Equivalent to a 13 month of North Slope Production. •Provides gas for Cook Inlet utilities, industrials, jobs, royalties, taxes. Fiscal Impact to the state of Alaska •Incentive will be clearly positive to State of Alaska, factors are... -How many developments will be incentivized? -How much gas will be discovered? -What will be the gas sales price (royalty value)? -How much will be spent for exploration and development? -Successful efforts driven - no incentives for dry holes •Conceptual Estimate of Impact, assumptions: -Varied field size from 0 to 500 BCF -Development Cost $0.50/mcf -Royalty - 12.5% -Severance Tax - 7.5% -Ad valorem - 2.7% -Gas sales price - $2.50/mcf Mr. Barnes referred to a table on page 13 (copy on file), which illustrates the relationship between field size (BCF), tax credit, gross revenue, royalties, and severance tax. The table gives total tax per field size. Conclusions •Based on conceptual model, State of Alaska receives from $3 to $10 additional revenue for each $1 of tax credit. •Credit is needed now! -Not enough exploration in Cook Inlet to meet demand. -Other areas of state need exploration and development. -New discoveries will take a minimum of 3 years to bring to first gas - Success Measures •Increased Lease Activity •Increased Drilling Rig Activity •Increased Construction Activity •Increased Production and Deliverability •Credits Applied to Income Tax -For every dollar of credit approximately ten dollars  were spent successfully developing new reserves, and ultimately paying new taxes! Representative Croft referred to the sponsor statement that noted "historic low natural gas prices". He then compared this with page 8 of the presentation, which noted "gas price increases". He asked why the increased prices would not create a natural incentive for exploration. Mr. Barnes acknowledged that price increases provided some incentive. He noted that exploration was a risky business, and offered no guarantees of success. He pointed out that the time lag between price shifts and discovery of new supplies could cause potential damage to local industry. He drew the analogy that stores run sales to encourage activity. Representative Croft acknowledged the potential benefit of the bill if it created activity that would not occur without it. He observed that it was difficult to determine whether the company would have increased exploration without the incentive, but conceded that if only one out of ten new reserves were developed due to the bill, the state would "break even". Representative Stoltze asked if a "double dip" was possible if a company took a reduction for royalties and also for Agrium [Company]. Representative Chenault maintained that the bill did not allow for multiple incentives. Representative Croft asked for clarification, and observed that a producer might qualify for the tax credit, and then not have to pay the royalty that they would have passed on to Agrium. Representative Whitaker suggested that any double credit would be very minimal. Co-Chair Harris referred to sub section (g) "A taxpayer who obtains a credit under this section may not claim a tax credit or royalty modification provided for under any other title." He observed that the bill pertained to corporate income tax, no more than 50 percent of the tax owed to the State in any year, and that to qualify a project must be producing gas or oil for the state of Alaska. He speculated that the potential risk for the State might be a portion of corporate income tax, but that this would be offset by a greater amount of royalties and severance. He asked whether the risk was minimal compared to the potential gain. Mr. Barnes concluded that successful exploration would reward the producer with corporate tax credit, and the higher production level would reward with additional revenue. Co-Chair Harris noted that the bill provided incentive for producers to invest into Alaska as opposed to other areas or countries. Representative Hawker referred to the successful efforts restriction in the bill and asked whether the proposed investment tax credit would apply to expenditures that were for an existing reserve, rather than a new reserve. Mr. Barnes commented that the intent was to qualify expenditures for bringing to production new reservoirs. He defined those new reservoirs as those in which no sales had previously occurred, whether a new or existing reserve. In response to a question by Representative Hawker, Mr. Barnes confirmed that if a producer found product in an existing well, those development expenditures would qualify. Representative Hawker referred to the qualifying expenditures language. He asked if the bill accommodated a situation when money was expended in a particular year and the reserve produced after the end of that tax year. He suggested that an accounting problem might exist in the language. Mr. Barnes observed that this accounting question had not been previously addressed. He assumed that, in such a progressive project, expenditures were held in aggregate and accounted for when product was sold. Representative Hawker referred to page 2, line 7, stating that qualifying expenditures must be "made for assets first placed in service in the state during the tax year in which the credit is claimed". He speculated that if a credit could not be claimed until a reserve was proven, it would exclude any expenditures made in the exploration process prior to the year in which the reserve was proven. In response to a question by Representative Whitaker, Mr. Barnes reiterated that the credit would apply to production from either an existing well or a new reserve that produced new gas sales. Representative Whitaker referred to page 2, line 7, and asked if Mr. Barnes was satisfied with the existing language. CHUCK LOGSDON, CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF REVENUE testified via teleconference. He was not able to comment on the language. He stated that he assumed the credit could be taken after an asset was placed in service, but noted that this may not be the correct interpretation. MARK MEYERS, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES concurred with Mr. Logsdon's interpretation of the credits being transportable. Representative Croft noted that the language made a distinction between qualified capital investments and qualified services. He maintained that qualified capital investment could be carried over, whereas qualified services (such as labor) were in question. He noted that a distinction was made between expenditures for capital investment, and for the services that could apply only to the specific tax year. HB 61 was HEARD and HELD for further consideration.