HOUSE BILL NO. 387 "An Act relating to a tax credit for certain oil and gas equipment in the Cook Inlet sedimentary basin; and providing for an effective date." 2:25:25 PM REPRESENTATIVE TOM MCKAY, SPONSOR, explained that HB 387 attempted to help oil and gas development in the Cook Inlet. He realized that a "jack-up" rig would be required if drilling activity in the inlet were to be increased. The current rig in the inlet was being fully utilized drilling wells for Hilcorp. He explained that it was not possible to drill year-round in Cook Inlet but it was possible to drill from approximately May through October with a jack-up rig. He thought the rig was needed in order to increase production. He read the sponsor statement (copy on file): As we face the reality of a shortage in natural gas production in Cook Inlet, the backbone of Southcentral Alaska's energy supply, the urgency to act has never been more critical. Cook Inlet gas has been an invaluable resource as an affordable, reliable energy source that has powered homes, businesses, and industry for decades. Projections indicate a rapid decrease in gas supply in the coming years under the current market conditions, a scenario that threatens the energy security of over half of Alaska's population and could lead to our reliance on imported Liquefied Natural Gas (LNG), which is likely to be significantly more expensive. Jack-up rigs are specialized offshore drilling rigs necessary for developing Cook Inlet gas reserves. Currently the state has only one rig available, a handcuff on any significant increase in drilling activity. The bill proposes a targeted incentive that will increase the project economics for investing in another jack-up rig to be used in Cook Inlet to explore for and extract natural gas by providing a carry-forward tax credit equal to the costs associated with purchasing and transporting the rig to Alaska. HB 387 has a clear goal: to increase exploration and production activities, thereby enhancing Cook Inlet gas reserves and increasing gas production. I urge my colleagues of the 33rd Legislature and the people of Alaska to support, HB 387 as a step towards energy development, economic resilience, and the long- term prosperity of our great state. 2:28:58 PM TREVOR JEPSEN, STAFF, REPRESENTATIVE TOM MCKAY, introduced the PowerPoint presentation "HB 387 Cook Inlet Jack-Up Rig Credit" dated April 4, 2024 (copy on file), and began on slide 2. He relayed the projected Cook Inlet gas shortage would threaten the energy security of the Southcentral region of the state and there could be a potential shortfall as early as 2027. A public opinion poll from July of 2023 suggested that 72 percent of residents reported a high level of opposition to importing natural gas and 60 percent of residents supported incentives for oil and gas companies to find and produce more Cook Inlet gas. He noted that residents' opposition to imports decreased markedly in the unlikely scenario that liquified natural gas (LNG) imports would be cheaper. Many stakeholders, such as the Alaska Energy Authority (AEA), believed that LNG imports would be significantly more expensive than locally produced Cook Inlet gas. He argued that the legislature owed Alaskans a solution to help incentivize more Cook Inlet gas exploration, production, and development. He relayed that figure 1 on the slide showed the projected fuel costs for coal, natural gas, LNG, and diesel over the next 16 years. The information was compiled by AEA. The actual price of gas to the consumer was unknown and the numbers were projections, but it was worth considering the projections when making policy decisions. Mr. Jepsen continued to slide 3 and explained that jack-up drilling rigs were specialized rigs in the mobile offshore drilling unit class and were intended for relatively shallow waters up to roughly 500 feet. The rigs consisted of a floating hole that could either be self-propelled or pulled by a barge to a drilling location. The rigs had extendable legs that provided the support for the rig on the sea floor. He stressed that jack-up rigs were necessary to develop offshore Cook Inlet gas. The slide included a drawing of the different mobile offshore drilling classes, not drawn to scale, and the jack-up rig was circled in red. Mr. Jepsen continued to slide 4 and relayed that there was presently one jack-up rig in Cook Inlet. The bill was solely focused on implementing a second rig in the inlet, which was required in order to adequately explore and develop gas reserves. The current jack-up rig in Cook Inlet, Spartan 151, would be fully utilized by Hilcorp for the foreseeable future. He explained that any new major developments would require a second rig. The decline in the Cook Inlet gas shortage projections did not account for a potential second rig in the inlet. In addition to developing known reserves in Cook Inlet on state land, there were federal leases in Cook Inlet which were too deep below the surface for the Spartan rig to operate in and a more capable jack-up rig was needed. Market interest had shown that investing in Cook Inlet exploration and production was not a highly popular option. The primary factors came down to risk and rate of return. The high cost nature of oil and gas exploration and development operations in Cook Inlet directly impacted both risk and rate of return. The state fully or partially subsidizing the purchase or transfer of another jack-up rig to develop Cook Inlet offshore reserves would offset the risk and increase the rates of return for a potential project. There was some risk to the state, but a "silver bullet" solution to address Cook Inlet did not exist. He reiterated that Alaskans wanted incentives to be offered and HB 387 represented a strong incentive to implement a second rig in Cook Inlet. Mr. Jepsen continued to slide 5 and explained that the bill would introduce a Title 43 tax liability reduction credit, which was not a cash credit. The credit was equal to 100 percent of the cost of purchasing and transporting a jack- up rig to Alaska limited to a maximum credit value of $75 million. The credit would only apply to jack-up rigs for Cook Inlet and included language that would ensure the rigs were used for at least three years, which would disallow the credit to be used as a pass-through in order to move the rig to a different location. He thought that the risk to the state was not as large as it may seem because the new rig would benefit Alaskans if the rig was used in Alaska for three years. There would be no cost to the state if the credit was not utilized and the state did not acquire a second jack-up rig. 2:34:37 PM Mr. Jepsen relayed that there was an old jack-up rig credit which was a drilling credit that was only applicable to drilling costs for a rig exploration well that was drilled with the jack-up rig. The only possible recipients of the old credit were oil and gas companies. The new credit proposed by the bill was for any Title 43 tax liability and would not be limited to oil and gas companies' drilling. Co-Chair Foster invited Mr. Jepsen to review the sectional analysis. Mr. Jepsen reviewed the sectional analysis on slide 6 (copy on file): Section 1: Amends AS 43.98 by adding a new section (43.98.080) which introduces a tax credit for persons installing a jack-up rig in the Cook Inlet sedimentary basin. Section 2: Repeals a prior jack-up rig drilling credit Section 3: Provides for an immediate effective date. Representative Galvin asked why the jack-up rig was chosen to be in federal waters as opposed to state waters. Representative McKay responded that the intent was to allow the rig to be utilized in state waters or federal waters. He explained that jack-up rigs were typically leased from the Gulf of Mexico or Southeast Asia. There were three important elements of jack-up rig drilling: the depth of the water, the desired drilling depth, and configuration of the drilling platform. If a drilling platform was set at a location with known gas, the important information to know was the water depth, the platform height, and the depth of the wells to be drilled. The appropriate jack-up rig could then be acquired with the known specifications. He reiterated that the intention was for the rig to work in state or federal water. Representative Galvin asked if there was a reason why a project on the water was chosen over a project on the land. She understood that there was gas available everywhere and wondered if there was a reason that the focus was on Cook Inlet. 2:38:43 PM Representative McKay responded that there were already land rigs on the shore and some of the bigger gas prospects were offshore. Representative Galvin asked how the bill would be an improvement upon what had already been done in the past. She was aware that the state had spent hundreds of millions of dollars in the past on new rigs and the efforts were unsuccessful. She asked why Representative McKay thought the bill would be more successful than past efforts. Representative McKay responded that in many of the energy focused bills he was sponsoring, he was trying to leverage reserves that were in the ground already instead of taking funds out of the treasury. He thought leveraging existing reserves would have a different result than past efforts. He did not want to criticize what was done in the past and he was certain the intentions were good. He relayed that there was gas in the ground that may not be produced unless the state leveraged and incentivized operators to monetize it for the benefit of all Alaskans. He explained that his energy bills were all structured to leverage reserves rather than utilize cash from the treasury. He suggested that Mr. Jepsen could add more details. Mr. Jepsen clarified that the bill was not specifically targeting federal waters or state waters. He continued that the older version of the jack-up grid credit was specifically for drilling costs associated with exploration wells. The credit would only apply for the first three exploration wells with a jack-up rig and it was limited to $25 million for the first well, $22.5 million for the second, and $20 million for the third. The credit proposed by HB 387 intended to keep the jack-up rig in the state for three years with the assumption that it would be drilling nonstop. The rig could be drilling exploration wells or development wells. The bill would ensure that the three- year drilling contract was in place and that the rig would be working nonstop to meet the gas demand. 2:42:24 PM Representative Galvin understood that the credits would not be displacing revenue. Mr. Jepsen replied that the state would be reimbursing oil companies and gas companies, but there was a benefit to Alaskans because the rig would be in the state for three years and it would be drilling nonstop. The payout of the credit would be a reimbursement, but it would still be leveraging gas in the ground because both exploration wells and development wells would be eligible. He argued that the drilling of the wells for a significant period of time would benefit the state. BRANDON SPANOS, ACTING DIRECTOR, TAX DIVISION, DEPARTMENT OF REVENUE (via teleconference), explained that the way the tax credit was structured was that the credit could be applied against the taxpayers' tax revenue in the year in which the credit was claimed. The credit would first need to be earned, which would generally line up with the taxation time period. For example, if a taxpayer brought a rig up to Alaska in 2026 and also had production tax due in 2026, the taxpayer could apply the credit in 2026. If there were any credits left over, the taxpayer could apply the credits in subsequent years. Representative Galvin understood that the credit would only be earned if the tax bill was over $75 million. She asked for confirmation that a company would be receiving the credit in exchange for a promise that it would drill for at least three years. Mr. Jepsen responded in the affirmative. Representative McKay commented that everyone had seen the projection that showed there would be a gas gap in approximately 2027 or 2028 and the earliest date LNG would be imported was 2030. The intended purpose of the bill was to bridge the gap to ensure that the state had sufficient gas supplies at least until the state had the ability to import LNG. 2:46:31 PM Representative Cronk asked how long it would take for gas to be utilizable if the second jack-up rig was drilling and hit gas. He understood the process would not only involve finding the gas, but also building the pipeline. He asked how long the entire process would take. Representative McKay responded that there would be a certain amount of pressure to take action quickly to allow the industry to react and plan. He explained that it would take two to three years to procure a new platform. Any new platform would need a subsea gas pipeline to shore and tie the gas into the NSTAR gas line. He noted that the process would take time and none of the steps could happen quickly. There could hypothetically be around 30 new wells after three years between two different platforms. Offshore work was time intensive, but it had been done before in Cook Inlet and could be done again. Representative Cronk understood that if there was a new field in the water, a new platform would need to be built before any drilling could occur. Representative McKay responded in the affirmative. He explained that subsea developments were the only developments that did not need a platform because the wellheads were on the sea floor. Most scenarios that would work for Cook Inlet were centered around building a new platform. The platform would likely be built in Korea or Japan and transported to the state and then the platform would be anchored to the sea floor. The jack-up rig could then drill the wells and begin production. The process had been employed in the inlet for decades. 2:49:34 PM Representative Cronk asked how long a jack-up rig would take to get to Alaska in the best case scenario. Representative McKay responded that the jack-up rig would likely come from the Gulf of Mexico and could either be towed up or hauled up to the state. The rig would be mobilized in summer or early spring. He acknowledged that it was a substantial operation and required supply vessels, materials, and manpower, among other resources. Representative Coulombe commented that she liked the bill. She referred to slide 3 which detailed the various types of drilling rigs. She asked why the bill would not be expanded to other types of rigs for future drilling purposes. Representative McKay responded that jack-up rigs were the most efficient and the most economical. There had been drill ships used in Cook Inlet in the past, but the rigs had to be dynamically positioned, which required a significant amount of power. The ships were designed to sit in the tides without moving, which required a tremendous amount of fuel. Representative Coulombe understood that there was only one jack-up rig in the inlet currently and it was being fully utilized by Hilcorp. She asked Representative McKay how confident he was that there would be enough drilling opportunities to keep the two jack-up rigs busy. Representative McKay responded that determining the scope was up to the private sector. There were two gas reservoirs that could be exploited and two platforms, which would take at least two years to drill to completion. He noted that it was a hypothetical situation at the moment. He thought the legislature was responsible for setting up the environment and the industry was responsible for deciding how to proceed. The projects would likely proceed if the legislature was able to ensure that the projects would be economically viable. He pointed out that none of his energy bills required that the state take action, but instead offered opportunities to the private sector. He thought that the private sector knew how to operate drilling projects better than the state. The role of the state was to offer incentives and put forth appropriate legislation. The owner of the potential jack-up rig in the Gulf of Mexico or Southeast Asia would likely not likely bring the rig to Alaska for an abbreviated program, but for a two- year or three-year contract to ensure that there would be a return on investment. 2:55:06 PM Representative Josephson understood that the credit was not limited to oil and gas companies. He asked which party would receive the tax credit in the following hypothetical situation: a jack-up rig drilling in the Gulf of Mexico was not producing oil and the owner of the rig decided to enter into a contract with an oil or gas producer in the Cook Inlet. He assumed that the producer would receive the credit and the producer would enter into an independent contract with the owner of the jack-up rig. Mr. Jepsen responded that the tax credit was structured to apply to any Title 43 tax liability. The intent was to open up the credit eligibility to Alaska Native corporations that do not drill for oil or a transportation company with a high corporate income tax liability. The credit would make it easier to transport the rig to Alaska, lease the rig, and become the owner of the rig, which would make the rig an asset to Alaska. He explained that the overall idea was not to limit the credit to oil and gas companies and allow other corporations or entities in the state to potentially become an owner of a rig. Representative McKay added that Representative Josephson had described a typical scenario. He explained that an oil and gas company would contract with a drilling contractor and pay the contractor to lease the rig, then the oil and gas company would receive the tax credit. Representative Josephson provided a hypothetical example where the Northwest Alaska Native Association (NANA) initiated the development. He asked if the corporate taxes would be written off against NANA's assets or if the credit would belong to the ultimate developer. In the example scenario, NANA would be the general contractor. Representative McKay responded that he would offer a different example. He relayed that Doyon Incorporated would be considered the parent company, and beneath the parent would be Doyon Drilling. The two were considered separate divisions. He noted that Doyon could contract or purchase a jack-up rig which would become part of its fleet, but it would have nothing to do with Doyon's other divisions and their other businesses. Representative Josephson asked if Mr. Spanos could respond to the question. 2:59:18 PM Mr. Spanos responded that he understood that the question was how the credit would be applied if a non-producer were to take on the cost of bringing up a jack-up rig to the state. He relayed that it would depend upon the company. If the company was a C corporation, the credit would apply against its AS 43.20 C corporation taxes, which were net income taxes. If the company was another entity with a different type of tax, such as a fishing company, the company could bring up a jack-up rig and apply the credit against its fish taxes. Representative McKay thanked the committee for its time. HB 387 was HEARD and HELD in committee for further consideration. Co-Chair Foster reviewed the agenda for the following day's meeting.