HOUSE BILL 207 "An Act relating to adjustments to royalty reserved to the state to encourage otherwise uneconomic production of oil and gas; relating to the depositing of royalties and royalty sale proceeds in the Alaska permanent fund; and providing for an effective date." KEN BOYD, ACTING DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES, explained that HB 207 was designed to clarify and expand existing law. Mr. Boyd provided a sectional analysis of the legislation. Section #1 would provide the "Legislative Intent". Section The State of Alaska has had a royalty reduction provision in 3 order since statehood. This section would also expand the current law and would provide the commissioner the ability to reduce royalties for future production. Section #2 is considered the sustentative portion of the bill and addresses where the law applies, and also defines a "field". Mr. Boyd continued, the Commissioner may not grant a reduction of royalty unless the lessee requests that reduction and then makes a clear and convincing showing that the reduction would meet the requirements of that section and would be in the best interest of the State. The royalty reduction agreement condition would specify that a royalty reduction could be granted by making reference to a sliding scale royalty or an equivalent provision providing for an adjustment to protect the State's interests. Mr. Boyd added that the commissioner could not grant a royalty reduction for a field, pool or portion of a field or pool that exceeds 75%, or royalties supplied requiring the balance to be at least 25%. Representative Parnell questioned the logic of establishing the 25% balance number. Mr. Boyd countered there had been no formula used to achieve that number and that the Administration ascertained that it would be a reasonable floor. Representative Navarre asked if the ELF contribution tax would be at zero. Mr. Boyd replied that in many cases, the ELF would be near zero. Mr. Boyd noted that Section #3 was the most important part of the bill. It clarifies that the commissioner may not reduce royalty on leases in connection with a cooperative or unit plan except as provided in (j). Sections #4 & #5 were added in the House Resources Committee to address the spacing units and pieces of development contracts. (Tape Change, HFC 95-79, Side 1). Representative Brown inquired if the actions recommended in HB 207 would be similar to the disposal of State land and resources requirements referenced in AS 38.05.945. Mr. Boyd responded that language had been added in the previous Committee and that he did not know the answer. Representative Brown referenced Page 2, Lines 4-13: "...not yet produced" field. She asked if it would be possible to have a reduction on only one stream in an area that produced more resources. Mr. Boyd acknowledged that could occur. Representative Brown asked if Prudoe Bay had produced gas 4 for sale to date. Mr. Boyd responded there has not been a major gas sale to date although, there have been transfers and sales of gas among the fields. Representative Brown questioned how the language on Line 10 would apply to that situation. Mr. Boyd stated that language would not be a result but would be part of the clear and convincing showing that a royalty reduction would be a difficult case to make. Representative Brown questioned if the commissioner would have the authority to require production in return for lowering the royalty. Mr. Boyd stated that the commissioner currently has that authority, and that the legislation would not change it. Representative Brown expressed her fear that a company could request a royalty and then not proceed with the production. She suggested modifying the language on Page 2, Line 31 to be more broad in order that the commissioner could condition the agreement in any way necessary. Mr. Boyd pointed out that if a company does not produce oil, the royalty reduction would be meaningless. PATRICK COUGHLIN, ASSISTANT ATTORNEY GENERAL, OIL AND GAS MINING SECTION, CIVIL DIVISION, DEPARTMENT OF NATURAL RESOURCES, explained the standard used to prolong the economic life of a field would require a determination that the State has achieved a maximum economic return as well as that the field is and would likely continue to be insufficient to produce a reasonable rate of return. He added, those standards have been deleted from the bill. Representative Brown referenced the last phrase on Line #16, "any increase or decrease is sufficient to make future productions no longer economically feasible". She thought there could be other factors driving the situation. Representative Grussendorf spoke to the owner/state doctrine, acknowledging that in that philosophical base, all resources belong to all the people of the State and any revenue derived from those resources should be disbursed. Representative Grussendorf referenced Page 4, Line #31, "the commissioner's written determination regarding royalty reduction is final and not appealable to the courts". Mr. Coughlin pointed out that the Legislature has adopted such language at previous times. The meaning of such phrases has been appealed and that the Alaska Supreme Court has stated that it will honor such a statement by the Legislature to the extent that it accords with constitutional guarantees. Representative Martin questioned the constitutionality of the language. He added, from information received from Dr. Logston, there are seven fields which are not charged taxes, 5 thus leaving only royalty collections on those fields. Representative Martin emphasized that continuation of the royalties was extremely important to the State. REPRESENTATIVE SCOTT OGAN noted that the bill requires that the commissioner transmit copies of the action to the presiding officer of each Body and the Chairs of the Resource and Oil and Gas Committees. He stressed that the "findings" would not be appealable. He questioned at the time in which the finding was transmitted, would that be the formality or would the Legislature then have the ability to add into the decision. Mr. Boyd replied that they would not, although the Legislature would have the same opportunity during the public notice process to comment. Once the "findings" were established, the results would be available for the use and review of the Legislature. Representative Brown questioned the issue of the competitive sale process and that relationship to the bill. Mr. Coughlin agreed that there is a possibility that a bidder could be treated unfairly. All leases issued by the State of Alaska since statehood have had a provision which specifies that the royalty can be reduced under certain circumstances. Mr. Boyd added that the commissioner would be required to consider the factors of delineation of each field. The applicant would be required to be at the field for a specified amount of time and had done some work in order to be able to apply for the royalty reduction. Mr. Coughlin added, under existing law the same problems could occur, and would reflect the integrity of the bidding process. PAUL WESSELLS, (TESTIFIED VIA TELECONFERENCE), DIRECTOR OF TAX, B.P. EXPLORATION, ANCHORAGE, spoke in support of HB 207. He stated that the legislation would be an important step in developing a new type of relationship for the State of Alaska and the petroleum industry. That relationship would be based on interest in common. MIKE BRUNER, (TESTIFIED VIA TELECONFERENCE), ANCHORAGE, voiced opposition to the proposed legislation and asked if there was a provision included in the legislation which would increase oil royalties to amounts higher than currently exist. Mr. Boyd referenced Page 3, Lines 2-3, "...under this paragraph, the commissioner shall include provisions in the agreement to increase or decrease the state's royalty share based on relevant economic factors". He added that the commissioner has the authority to establish the royalties lower initially in order to get the project "off the ground" with the option to modify that provision. 6 Mr. Bruner understood that the commissioner did not have the authority to raise the fee higher than established in the original lease. Mr. Boyd stated that information was incorrect and had resulted from the agreement between the State of Alaska and a certain company. Mr. Bruner concluded, there has been no historical incentives to producing oil for companies and he felt that the rate of return should benefit only the State. RICHARD FINEBERG, RESEARCH ASSOCIATES, ESTER, ALASKA, spoke in opposition to the legislation. [Copy on file]. He summarized that there is a strong substantive case for easing the State's existing royalty relief provisions as proposed in all versions of HB 207 to date. He referenced specific areas: 1. Production trends. 2. Comments on production trends. 3. Profitability Mr. Fineberg continued, HB 207 contains serious structural defects. 1. Procedures for royalty relief should be clearly framed and the need for royalty relief should be clear to the owners of the resource. (Tape Change, HFC 95-79, Side 2). 2. Economic considerations should include an analysis of pipeline profits. 3. Blanket confidentiality. The requirement that the Commissioner shall hold application material confidential at industry request contravenes the state's laws, common sense and jurisprudence. 4. Contractor analysis. 5. Judicial review. He stated that it was easy to understand why the industry would like to remove judicial review. Mr. Fineberg concluded that the current approach to incentives is flawed. In the policy arena, where the mission is to protect the public interest in both the revenue stream and the environment, industry desires must be balanced against those concerns. It would be self-evident that any bill that increases industry revenue at the expense 7 of the State Treasury would tend to stimulate production. The industry would advocate such a measure. If the provision which grants confidentiality at the lessee's request were removed or replaced with language that guarantees public access to information necessary to evaluation of public policy, it would be necessary to demonstrated that the legislation would be necessary. Mr. Fineberg summarized, in view of the well documented history of abuses of confidentiality, it would make little sense to allow the lessees, at their own initiative to prevent it from materializing. REPRESENTATIVE NORMAN ROKEBERG noted that he was the Chair of the House Oil and Gas Committee and spoke to the significant amount of effort and activity that went into preparing the legislation and the committee substitutes. The objective of the Oil and Gas Committee was to develop a framework around the commissioner's discretion and to protect the citizens of Alaska and their resources Representative Rokeberg commented on the philosophy of the legislation. He emphasized that Alaska is competing in a global market. It is clear that B.P. Exploration and ARCO are the two major investors in the State which also have significant interest in the North Sea. Those governments have revolutionized their tax system to accommodate that interest. He added, without the legislation there would be no new capital investments made in the State. There has not been one royalty reduction made in Alaska. The legislation will clarify problems from the past while making adjustments to new fields. Representative Rokeberg recommended five areas within the proposed legislation which should be focused on. He explained that the Oil and Gas Committee made a differentiation between new and old fields. He added that the major controversial areas are in the imposition of the floors. The original bill made a provision for a "hold harmless" for the Permanent Fund thus establishing artificial floors, 50% on leases occurring after 1980 and 25% on leases before that time. Following significant testimony and review, it was determined that there were no constitutional bounds. The Oil and Gas Committee returned language to the status quo: "Any royalty payments made to the State of Alaska should be shared between the general fund and the permanent fund". Representative Rokeberg continued, an additional issue reviewed by the Committee was the oversight provisions on 8 Page 3, Section 6. The Committee adopted the Alaska Royalty Advisory Commission Board as an oversight group to analyze the commissioners discretion. In the House Resource Committee, it was decided to use public notification and review. Representative Rokeberg requested that House Finance Subcommittee deliberate this area. Representative Rokeberg offered his assistance to the House Finance Subcommittee in reviewing HB 207. He pointed out that the federal government is currently working on royalty reduction legislation. These royalty reduction bills will investigate deep water and frontier areas. Representative Brown asked Representative Rokeberg if consideration had been given to have the Legislature provide the required oversight. She recommended providing a disapproval mechanism within the bill unless approved by the Legislature. Representative Rokeberg responded that the Legislature and LBA had been considered. He added that a sunset provision would not be workable as the time frame does not lend itself to the interim schedule. He thought that the situation should not be "politicized" and felt it would be if the Legislature or LBA provided the oversight. PATRICK DALTON, (TESTIFIED VIA TELECONFERENCE), DELTA JUNCTION, spoke in opposition to HB 207. He stated that the bill would provide uneconomic production of oil and gas in the State. He added, the legislation would be an environmental risk. Mr. Dalton emphasized that if the State can not get what the minerals or resources are worth, they should be left in the ground. Mineral rights then could be allocated to the Alaskan residents. Co-Chair Hanley countered that there existed a difference in philosophy regarding the legislation. He placed HB 207 into Subcommittee consisting of Chair, Representative Therriault, and members Representative Parnell and Representative Brown. HB 207 was HELD in Committee for further consideration.