HOUSE BILL NO. 223 "An Act relating to the production tax and royalty rates on certain gas; and providing for an effective date." 1:36:46 PM REPRESENTATIVE GEORGE RAUSCHER, SPONSOR, introduced HB 223. He read the sponsor statement (copy on file): House Bill No. 223 represents a crucial step in revitalizing Alaska's critical natural gas industry in the Cook Inlet sedimentary basin and acts as a legislative response to the impending natural gas availability shortage. This bill addresses a longstanding barrier to new investment and production in this sector: the current royalty rates. By proposing strategic modifications to these rates, HB 223 aims to elevate Alaska's competitiveness and attractiveness for natural gas investments in new and underutilized fields. This legislation introduces a significant adjustment to the royalty rates and payments structure for certain oil and gas production, by reducing the royalty payments to zero for qualified new gas and cutting the minimum fixed royalty share by 50% for qualified new oil, this legislation creates a more favorable economic environment for energy companies to invest in untapped resources. These incentives are designed to catalyze the commercial production of oil and gas from fields or pools that have not been previously utilized for commercial sale before January 1, 2024. This legislation is a testament to Alaska's commitment to fostering innovation and investment within the energy sector, addressing the immediate challenges faced by the Cook Inlet and Railbelt region, and laying the groundwork for a prosperous and energy- secure future. The enactment of House Bill No. 223 will mark a significant step forward in achieving these objectives, demonstrating Alaska's proactive approach to energy policy and economic development. 1:39:11 PM CRAIG VALDEZ, STAFF, REPRESENTATIVE GEORGE RAUSCHER, read the sectional analysis (copy on file): Section 1: AS 38.05.020(a) Page 1, lines 7,8 This section amends the Authority and Duties of the Commissioner so they shall make determinations under new subsections (mm) and (nn) Page 1, lines 9 through 12 Directs the Commissioner to adopt regulations as necessary to carry out subsections (mm) and (nn), including differentiating qualified new oil and gas production from existing fields or pools. Section 2: AS 38.05.180 Page 1, lines 14 through Page 2, line 9 A new subsection, (mm), is added to introduce terms for complete payment of royalties due to the state for qualified new gas and oil produced from the Cook Inlet sedimentary basin, specifying a zero royalty for qualified new gas and a 50% minimum fixed royalty share for qualified new oil, under certain conditions. Page 2, lines 11 through 26 A new subsection, (nn), is added to define "qualified new gas" and "qualified new oil," including criteria based on production commencement dates and economic feasibility of producing from new wells. Section 3: Page 2, line 27 Repeal of Sections AS 31.05.030(i), AS 38.05.180(f)(5), and AS 38.05.180(dd): Simplifies the regulatory framework and aligns provisions with the current needs of Alaska's oil and gas industry, removing outdated or redundant criteria to encourage development and streamline operations. Section 4: Page 2, line 28 This Act takes effect immediately under AS 01.10.070(c). Co-Chair Foster asked if the sponsor would like to comment. Representative Rauscher added that there had been a couple of different versions of the bill, but the core of the bill remained relatively the same. The governor and his staff decided that the governor's version of the bill would merge with the existing version and elements from both bills would be combined. He explained that a representative from the administration was also available to talk about the bill. Co-Chair Foster suggested that the Department of Natural Resources (DNR) give its presentation. 1:44:35 PM JOHN CROWTHER, DEPUTY COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES, introduced the PowerPoint presentation "HB 233 Tax and Royalty for Certain Gas" dated April 4, 2024 (copy on file). He explained that Mr. Derek Nottingham would be providing the majority of the presentation. He hoped the presentation would help the committee understand the mechanics of the bill. The slides would detail the projected outcome of the bill, which was influencing new oil production. DEREK NOTTINGHAM, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, began on slide 2, which detailed the "runway" of Cook Inlet gas with the maximum state fiscal incentives. The slide did not reflect the specific impacts of HB 223, but examined the runway, which was the amount of gas that could be available if the state's fiscal system, production taxes, state property tax, and royalty were maxed out or taken to zero. He explained that the blue line was the forecasted runway. The gray line represented that technical forecast and did not include the commercial aspects of the individual fields and pools. The gray line was Cook Inlet's gas capability excluding any real commercial constraints. By simply reducing the fiscal system, the runway would build out to about 2029 and the shortfall would be below the 70 billion cubic feet (BCF) parameter. The projects that could be coming online in Cook Inlet could create a surplus if the projects were activated within the projected timeframe. The maximum runway was represented by the black dashed curve which showed when gas would be sold into storage, put away for later use, and then sold into the market in the future. The chart indicated that if the gas was brought online by 2037 and properly incentivized, it could be in the "cooking lab." 1:49:11 PM Mr. Crowther noted that there was a large amount of information on the slide. He thought that it was consequential to show that it was valuable to energy supplies if the fields could be brought online and continue to produce. The continuation of the fields would be dependent upon provisions found in HB 223 and similar pieces of legislation. He asked if there were questions. Representative Josephson understood that the technical forecast was synonymous with the term "no commercial restraints." He asked if Mr. Nottingham could elaborate. Mr. Nottingham responded that he meant that if the market was in line with the current fields and operating at a certain cost, the fields would continue to decline. He explained that as the fields declined, the per thousand cubic feet (MCF) cost increase in some fields within the next few years would not allow the fields to generate positive cashflow. The fields represented by the blue line would shut down because the fields would no longer be able to sufficiently operate at a profit. The technical forecast assumed that there was no requirement for a positive cashflow and the fields would technically be able to continue to produce if economics were not a factor. Mr. Crowther added that the cost presumptions, while presented to be informative, were technical and complex. He noted that the cost holding and the untruncated forecast did not take the consumer price into account. There was a price interplay that was not depicted on the chart but was an interesting proxy for what could be recovered irrespective of cost. If consumer prices dramatically escalated, the gray line could become more accurate than the blue line. He stressed that consumers would bear the cost. He remarked that it was a rough description of a very complex set of assumptions and deductions. 1:52:42 PM Representative Galvin had a question related to the tan colored portion of the chart representing known but undeveloped gas resources. She asked whether DNR currently had the authority to reduce the royalty if it would make a project more economic. Mr. Nottingham responded that there were specific statutes that allowed the department to reduce royalties. One of the issues was that the statutes had strict requirements in order to prove that the royalty modification was necessary. The process was lengthy and the outcome was uncertain for companies. He felt that it was important to provide certainty to potential developers in the Cook Inlet. Representative Galvin asked Mr. Nottingham why there was a need for something more broad-based and infinite. She understood that the department could already reduce royalties and it was not helping. Mr. Crowther responded that Representative Galvin was correct and the short answer was that the department could already offer royalty relief. There were a couple dynamics that made the process challenging for operators. The first challenge was the requirement to develop, submit, and review analysis data, and develop, according to the statutory standard, a very clear finding that the project is not economic. The submission then had to be reviewed by the Legislative Budget and Audit Committee (LB&A). Once the analysis was complete, it was a slow process for the modification to go into effect. While the authority was available, the benefit of HB 223 was that it would be easier to offer relief as the timeframe would be greatly reduced. A long analysis would not be required and there would not be a runway of uncertainty before data could be presented to the legislature and for the modification to be put into effect. The department had offered royalty relief on the North Slope for a few projects, but it was complicated and the legislation would immediately promote investment. 1:56:34 PM Representative Galvin understood that it was appropriate given the circumstances for a broad based form of relief as opposed to a more precise approach. She thought it was important for the legislature to understand the approach because some companies would already be taking in data to determine whether or not it was economic. She suggested that perhaps the state was asking for more information than was necessary. She agreed that the process sounded complicated. Representative Stapp asked what the material difference was between the various approaches. He looked at the maximum state fiscal incentives, zero royalties, zero production, and zero property tax at the bottom of slide 2. He asked why it would not be logical to simply allow the price to float upward to compensate for the margin. Mr. Crowther responded that there were a couple of policy considerations driving the choices. One of the considerations was that the market changes could be abrupt and contracts would need to be facilitated at different prices, which would then be subjected to a review which could frustrate financing up front due to the slow timeline. The other consideration was that the department aimed to develop natural resources of all kinds and the governor's energy policy was focused on access to renewables and working on transmission, among other topics. There were situations in which the price would increase above switching prices for other resources. The department thought the most effective strategy was to ensure that the state had a highly competitive royalty environment, was making appropriate investments, encouraging companies to make investments, and bringing resources into development in the near term. The goal was to allow the market and the price to compete for the best options and to extend the shortfall. 2:00:28 PM Representative Stapp asked if the issue was that the gas was available, but the projects would not yet make economic sense. There was either a problem with the cost for production, or the price at the point of sale. He understood that the bill would effectively make the cost at point of production as low as possible and the state would no longer receive royalties or property taxes. He suggested that the other way to accomplish it would simply to mandate that producers pay double the price in gas. He asked if it would have the same impact as the bill. Mr. Crowther responded that there was some price level that would have a similar effect, although the mechanics would be different. The purpose of the legislation was to control the levers to encourage investments. The price was already moderating in response to the supply, and both forces would likely drive increased supply. Representative Galvin thought that the bill could have a great outcome. She wondered if it would be pointless to offer relief for the whole lease time period, as opposed to a limited time frame such as 15 years to allow for income to build. Mr. Crowther replied that page 2, line 6 of the bill referred to a time limit in the 10 years following the commencement of commercial production that would begin after July 1, 2024. The legislation included a cap for the period under which royalty reduction would be available. There was a resource development potential in Cook Inlet that would continue to be present for years, and it was unlikely that there would be a massive expansion of supply. However, in the event that there was an expansion, a time limit would be in place. Representative Galvin asked if the department expected it to take 10 years before gas was developed and provided to Alaskans. 2:04:32 PM Mr. Nottingham responded that the royalty provision would only apply when a well was in production or development. The timeframe of 10 years was only applicable to the first 10 years of the production of the new pool. There was a slide later in the presentation that would show the typical timeframe for a major gas project in the Cook Inlet, which was four to six years. The 10-year timeframe would allow the project to achieve payout as well as provide some buffer time. Representative Josephson remarked that he was frustrated with slide 2. The slide said there were known but undeveloped gas resources and there would be more production if the state provided maximum fiscal incentives, of which he was aware. He was confused about the part of the slide that referenced "billion cubic feet." He thought that the slide demonstrated basic economic principles that he was already aware of, but beyond that information, he had not learned anything new. Mr. Crowther apologized for the ambiguity. He explained that the billion cubic feet per year referred to consumption per year. The intent was to show the production possibilities relative to the estimated demand of about 70 billion cubic feet per year. 2:07:07 PM Mr. Nottingham continued on slide 3 to explain why the legislation was necessary. He relayed that 70 percent of Alaskans used Cook Inlet Natural Gas for power and heating. Gas was forecasted to drop below the demand of 70 BCF per year within the next few years and action was needed. Improved fiscal terms would directly impact project economics, such as payout and rate of return for developing companies. Royalty reduction was a mechanism that DNR could implement expediently, and the resulting steps could be quickly accomplished by producers. Mr. Nottingham continued to slide 4, which showed the department's perspective on the mechanics of the bill. The yellow diamonds represented milestones or decision points in terms of whether the field or pool qualified. If a field or pool had never produced in the Cook Inlet before, it would automatically qualify. The bottom oval shape represented the decision points if a field was produced before 2024 but was not online during 2024. Bringing the field back online would qualify it for the royalty reduction. He clarified that there were three main qualifications: if a field was new, if a field was brought back online after a period of production but was shut in recently, and if the prospect fell outside of what existing wells could produce. Mr. Nottingham continued on slide 5, which he thought would answer some questions posed by Representative Stapp. The slide described the gas supply cost under the current royalty regime as compared to the royalty regime of HB 223. There were three examples on the slide that each showed a variety of outcomes on undeveloped gas resources. The first scenario was optimistic with a lower investment amount and cumulative resource of about 275 BCF and a development time of three years. Scenario two was a "mid-case" with an investment amount of $350 million, 250 BCF, and a development time of three years. The third scenario was a more pessimistic view with a higher investment amount of $400 million, a longer development timeframe, and 250 BCF. The scenarios did not reflect any one particular project, but were simply intended to provide information. Mr. Nottingham explained that the left side of the slide showed the cost of gas supply, which was the minimum price that investors needed in order to move forward. The chart assumed that one of the most important criteria was a payback time of around four years and a minimum annual return rate of 15 percent. The first three bars were the cost of supply under the current royalty regime for scenario one, two, and three, and the arrows tied back to the cost of supply under the royalty regime of HB 223. He explained that scenario two under the current royalty regime would cost $12.26 per MCF to the developer in order to onboard a project at the investor requirements of four years for payback and a 15 percent rate of return. The orange bar was the cost of royalty. If royalty was brought down to zero, the cost of supply would be reduced by $1.74 to $10.48. The cost would not be passed on to a consumer. 2:13:53 PM Representative Galvin wondered if it was possible that the bill would encourage a project to go offline for a year in order to qualify for royalties. She asked what the state would do to make sure that the system would not be manipulated. Mr. Nottingham responded that the intent was not to encourage manipulation. The legislation would not consider fields that were to be shut in during 2025 or 2026, only fields that were shut in during 2024 or earlier. Any manipulation of the system was protected by the date restriction. Mr. Crowther added that the department already knew which fields would be eligible for royalties. Representative Galvin asked for confirmation that the legislation would not incentivize manipulation of the system because the department already knew which fields would be eligible. Mr. Nottingham responded in the affirmative. 2:16:03 PM Mr. Nottingham continued on slide 6 of the presentation which detailed the economics from a hypothetical company's point of view. On the right-hand side of the slide, the graph showed the internal rate of return to the company, and the yellow line and the black line represented the internal rate of return under the royalty regime proposed by HB 223. The graph also included the internal rate of return for the current royalty regime under the same hypothetical company. As gas prices increased, the rate of return also increased, but there was an incremental internal rate of return benefit to the company of about 5 percent under HB 223 as compared to the current royalty regime. Mr. Nottingham explained that the left-hand side of the graph showed that the payback time was also improved. The payback time under the current royalty regime was represented by the gray bar and the payback time under HB 223 was represented by the blue bar. Under the proposed legislation, the payback time would be greatly reduced, thereby creating a financial incentive for companies. Representative Galvin asked what the 5 percent difference would translate to in terms of dollar amounts. Mr. Nottingham responded that he was uncertain, but the division's commercial manager could respond to the question. 2:18:55 PM JHONNY MEZA, COMMERCIAL MANAGER, DIVISION OF OIL AND GAS DEPARTMENT OF NATURAL RESOURCES (via teleconference), responded that slide 6 reflected the impact of the reduced royalty rates on the investment metrics potentially required by investors. If the internal rate of return was increased as a result of the policy, new projects would become available. He thought there would be a positive impact in terms of revenue; however, because there were a variety of potential scenarios and the scope of the new projects was uncertain, it was difficult to pinpoint the specific revenue impact. Co-Chair Foster asked Mr. Meza to model a few scenarios and provide the information to the committee. Representative Galvin added that the modeled scenarios would help answer her question. She asked if a specific number could be extrapolated in example scenarios. Mr. Crowther responded that he believed so. He understood that Representative Galvin was referring to project-wide costs. He confirmed that the division could develop scenarios and present the scenarios to the committee. HB 223 was HEARD and HELD in committee for further consideration. 2:21:54 PM AT EASE 2:24:55 PM RECONVENED