1 HOUSE BILL 362 "An Act extending the motor fuel tax exemption for fuel sold for use in jet propulsion aircraft to fuel used in those aircraft for flights that continue from a foreign country." Representative Therriault noted that HB 362 would extend the motor fuel tax exemption for fuel used in aircraft for flights that continue from a foreign country. Currently, the State of Alaska provides a tax exemption for fuel used only in flights to foreign countries. He added that federal law preempts state taxation of imported aviation fuel transported through a Foreign Trade Zone (FTZ) for use in aircraft during foreign flights. The federal definition of "foreign flight" includes flights originating from and flights continuing to a foreign country. Representative Therriault continued that two tankers filled with tax exempt foreign-produced fuel were brought into Alaska during 1995. It is anticipated that practice will increase as airlines move to purchase the tax exempt fuel for use in foreign flights at a lower cost than taxable Alaska produced fuel. He suggested that HB 362 was needed to provide a "level" playing field to Alaska producers by allowing the tax exemption for all fuel used in foreign flights. * Federal law preempts the state from taxing fuel in an Foreign Trade Zone (FTZ). * An FTZ allows for foreign refined fuel to be brought into the United States (U.S.), without a bond; the fuel may be coming with domestic product. The Customs Modernization Act (CMA) allowed that flexibility. * Bonded fuel is foreign produced fuel imported to the U.S. for use on foreign flights. Bonded fuel cannot be commingled with the domestic product; it must come into a dedicated facility. * Air carriers will purchase fuel from the cheapest source. * The FTZ in Anchorage creates an unfair tax advantage to foreign produced fuel. * The State of Alaska and the Alaska based refiners 2 did not create the inequity. * Two tankers filled with tax exempt foreign- produced fuel were brought into Alaska during 1995. It is anticipated that practice will increase as airlines move to purchase the tax exempt fuel for use in foreign flights at a lower cost than taxable Alaska produced fuel. * Revenue losses reflecting in the fiscal note would be lost anyway as carriers purchases additional tax exempt fuel. * Unless presented with an alternative solution, HB 362 is needed to provide a "level" playing field to Alaska producers. BILL STARK, (TESTIFIED VIA TELECONFERENCE), MANAGING DIRECTOR OF FUEL, FEDERAL EXPRESS, MEMPHIS, TN., spoke to the legislation which would "level" the playing field in open competition for the Alaska refiners who compete to supply jet fuel in Alaska. He noted that his responsibilities include researching the lowest cost fuel to the airlines that he represents. Mr. Stark added, that responsibility would include bringing foreign refined bonded jet fuel into Alaska if that would provide a savings. Mr. Stark added that if the Foreign Trade Zone did not exist, it would be less convenient for the carriers to bring foreign refined bonded fuel into the State. That fuel would not be commingled with the domestic fuel. It would have to be placed into another tank. Federal Express (Fed Ex) has built storage in Anchorage which could easily accommodate that fuel if required. For economic flexibility and operational reasons, it would be more convenient to be operated through the free trade zone and then mingle all of the fuel together. Co-Chair Hanley responded that bonded trade zone fuel would not be taxable. Mr. Stark pointed out that Fed Ex has used bonded fuel in the past two years and that fuel had passed through the FTZ. Representative Martin questioned if the State was relinquishing the tax too quickly in an effort to undermine the local distributor. Mr. Stark responded that the fuel was moved from the Middle East via a super tanker and then it was broken down. That product was then moved to three locations, Los Angeles, Hawaii and Anchorage. Only the Alaska portion made money. Chevron added a bonded tanker thus, that created a successful venture for them. 3 Co-Chair Hanley asked if it would be economically viable for Fed Ex to use fuel which cost one cent less than fuel in Alaska. Mr. Stark stressed that it would. Co-Chair Hanley asked if the three and half cent elimination as proposed was passed, would it then still be profitable for that company. Mr. Stark replied that it would be a profitable margin even at one-tenth of one cent per gallon, currently, the difference between market fuel and domestic fuel. Co-Chair Hanley questioned with the elimination of the tax, could a company still bring in fuel cheaper through the bonded market. Mr. Stark replied that would not be likely. However, in the Alaskan market with only three refiners available, the market can become too isolated. He suggested that it would be to the carriers benefit to bring in outside product. Representative Therriault pointed out that in other legislative committee hearings, there was discussion regarding whether other in-state refiners had a large enough profit margin to be able to absorb the tax and continue to be competitive. Representative Therriault contended, they would have too. The market has become out of balance as a result from FTZ operations. Co-Chair Hanley asked the cost difference between bonded fuel going through the Foreign Trade Zone and fuel that does not go that route. Mr. Stark noted that the cost would be below one-tenth of one cent different. Co-Chair Hanley advised that the issue at hand was not with the Foreign Trade Zone, but rather a problem with bonded fuel which allows the tax exemption. Mr. Stark pointed out that the bonded fuel concern result from a federal customs program. Representative Therriault pointed out that customs personnel would be required to review and oversee the transport and use of the bonded fuel. He noted that issue was more complicated than separate storage. Mr. Stark added that the accounting rules for losses and gains in fuel are the same for bonded and free trade zone fuel. Mr. Stark explained that bonded fuel which is formed by crude oil, is refined in a foreign refinery, then imported into the United States for use in international commerce for international commerce reasons. This fuel is considered to have not entered the United States because it is under customs bonds. Free trade zone fuel is foreign produced crude oil that is refined in a domestic United States refinery and used on international flights. Both these fuels are non-taxable because they have entered the states for commerce. There exists free trade zone storage and bonded storage. Under the free trade zone rules, bonded, 4 free trade zone and domestic fuel can be commingled. TOM JENSEN, (TESTIFIED VIA TELECONFERENCE), ADMINISTRATOR, Foreign Trade Zone #160, ANCHORAGE, stated that a Foreign Trade Zone is a site within the U.S. and in or near a customs point of entry. He stated that Anchorage, Alaska, was a point of entry. At those places, foreign and domestic merchandise is considered to be international commerce. A Foreign Trade Zone is a site designated by the U.S. Department of Commerce within the confines of the U.S. and is treated as a foreign place. Foreign or domestic merchandise, including petroleum can enter that zone without a customs entry or payment of excise taxes. The final product, when it leaves the zone and goes international, is not taxed. If the product, when it leaves that zone goes then to the continental United States, it is taxed, but only taxed on value of when it entered the zone. Co-Chair Hanley asked if Foreign Trade Zone administrators had the ability to tax fuel that comes into the Foreign Trade Zone. Mr. Jensen replied that as the grantee of the Foreign Trade Zone, the Municipality of Anchorage strictly administers that zone with federal rules and regulations. The United States customs determines what is taxable and non-taxable in that zone. Mr. Jensen stated there was not a lot of flexibility within the customs laws and regulations. Mr. Jensen reiterated that the zone is operated under federal rules and regulations; he explained what was taxable under federal law and what was not. This is not an arbitrary decision made by the grantee, but based upon written law. Representative Therriault asked if there were allowances and regulations used to base the decision on a particular product. Mr. Jensen responded that would not occur. He added, that in the process of activating the site of the Anchorage International Airport, which is state property, the State of Alaska negotiated a fifty year lease of the land as a Foreign Trade Zone, which is a place to service and store domestic and foreign fuel product. JOE PERKINS, COMMISSIONER, DEPARTMENT OF TRANSPORTATION AND PUBLIC FACILITIES (DOTPF), testified that the Administration supports economic development tools. As the Mayor of Anchorage, Governor Knowles began development of the FTZ in Anchorage as a means of attracting value-added business to the State. Commissioner Perkins concurred that there is a place for properly managed FTZ's in Alaska. HB 362 was introduced to "level" the playing field for in- state refiners to compete against foreign refined fuel being sold through the FTZ in Anchorage. By utilizing the FTZ, 5 foreign fuel is currently being sold to foreign flights continuing on to U.S. destinations without paying the 3.2 cents per gallon tax. He noted that the Administration supports Representative Therriault's intent to "level" the playing field for in- state refiners. However, the Administration believes that the problem could be solved administratively by changing the way the FTZ is operated rather than eliminating the current fuel tax. The intent of a FTZ would be to bring in new business, not to put existing businesses at a disadvantage. Commissioner Perkins stated that the Department supports utilization of FTZ's for that purpose, however, the way FTZ is now being used places business at a disadvantage. Commissioner Perkins emphasized that the legislation would increase revenue lost to the state by not collecting any aviation jet fuel on any overseas flights regardless of the fuel source. The Administration's solution will "level" the playing field by removing the advantage given to foreign refiners over in-state refiners by deactivating the FTZ areas at the airport that currently are being used for the purpose of avoiding the state tax. The purpose of an FTZ would be to provide protection from customs duties or government excise taxes within a restricted zone for merchandise or commodities before they enter the commerce stream. Generally, that protection is granted to allow time for manufacturing components or raw materials into a final consumer product. No state tax can be collected on fuel provided under the FTZ process. Commissioner Perkins continued, utilization of the FTZ protection involves a 2-Step process: 1). Formation and establishment of the protected zone and regulation by the FTZ Board in the Department of Commerce. The Board may approve any zone which it deems to adequately serve the public interest. 2). The U.S. Customs service must approve activation of the zone before any merchandise is admitted under FTZ protection. When "activated", that zone is then legally considered outside the customs territory of the U.S. FTZ status is granted to entities authorized under State law whom apply to the Board for that protected status. The "grantee" may either contract with an operator or operate the zone itself. The original intent for the Anchorage FTZ was to have the State and the Municipality jointly share the authority. At that time, State law AS 45.77.010 did not 6 authorize a joint application. That was changed in 1988. In 1987, DOTPF agreed to include airport land in the FTZ with the conditions that; the State of Alaska be responsible for the management, the State would have equal representation on any board formed to oversee FTZ activities, and would retain veto power over any decision made by the board which affects airport property. A corporation was never formed and the transfer of management authority never occurred. Commissioner Perkins summarized the current situation. Foreign refined jet fuel is being sold to carriers that are arriving from a foreign country and then continuing on to a U.S. destination without paying the State's 3.2 cents per gallon fuel tax. In 1995, 2 tankers docked at the Port of Anchorage with aviation jet "avjet" fuel which was sold through the Foreign Trade Zone. Each tanker contained 10 million gallons of fuel, resulting in total State lost revenue of $600,000. Commissioner Perkins pointed out that HB 362 would expand the exemption currently enjoyed by flights to foreign countries to include flights from foreign countries, refueling in Alaska, and continuing on to U.S. destinations. The expansion of the exemption would cost the State of Alaska between $3.5 and $4.6 million dollars a year. Commissioner Perkins concluded that the situation can be resolved by administrative means. The Administration believes that the current utilization of the FTZ to be contrary to its original intended purpose. They recommend that it should be corrected. Co-Chair Hanley reminded Commissioner Perkins that Mr. Stark had testified that Federal Express intended to take this action regardless if FTZ existed or not. They currently have storage facilities. He indicated that the difference in cost would be less than 1/10 of one-cent per gallon. The only difference would be the commingling. Co-Chair Hanley understood that with such a small margin to deal with, the Foreign Trade Zone should not make a difference. He requested the Department to provide more in depth research on bonded fuel, to indicate if the previous testimony was correct. Commissioner Perkins responded to Representative Navarre's question, noting that the International Anchorage Airport was part of the FTZ. Representative Navarre asked if the International Airport could withdraw from the FTZ. Commissioner Perkins replied that the State could initiate proceedings to withdraw, although it would be easier if the administrator of the FTZ agreed that it should be changed. 7 Procedures for changing do exist. The State has not investigated other options available to changing the current situation. (Tape Change, HFC 96-67, Side 2). Representative Martin asked what the benefits were to Alaska to encourage use of the FTZ. Commissioner Perkins replied that cargo activity at the Anchorage International Airport involves mainly fuel. In the last five years, there has been a 25% increase in the use of that airport for international cargo. That statistic places Alaska in the first to third category in total tonnage of cargo moving through the airport. All that activity has been done with the current fuel tax imposed. The airport has grown with that tax. In relationship to other states, Alaska tax price is competitive. Commissioner Perkins continued, United Parcel Service (UPS) has announced plans to triple the size of their facility in Anchorage airport. Federal Express is designating a new building to train their flight crews. They have also just received rights for two more flights to China per week. Northwest Airlines is currently evaluating options for more international parking and handling facilities. Other firms are in negotiations to construct a multi-tenant cargo facility for international foreign cargo. The current tax structure has been factored into the negotiations with the above mentioned business. Representative Therriault agreed that the benefit of the FTZ for Alaska is the creation of jobs. He pointed out that fuel flowing through a pipeline has not created that many jobs. The benefit to the State has been the fees that the Municipality of Anchorage has been able to generate through operation. Mr. Jensen stated that $25 thousand dollars per vessel was generated through fees last season for use of port facilities. Two fuel vessels did use that facility. Representative Therriault referenced the Board's language of purpose: "The Board may at any time order the exclusion from the zone of any goods or process of treatment that in its judgement is detrimental to the public interest, health or safety". Representative Therriault thought that the legislation would be "enhancing" to public interest. Co-Chair Hanley asked if the tax were removed, what would be 8 the profit margin and how would that amount be used. He understood the competitive difference to be one-cent. BOB BARTHOLOMEW, DEPUTY DIRECTOR, DIVISION INCOME & EXCISE AUDIT DIVISION, DEPARTMENT OF REVENUE, replied that there was not enough information available to determine a refiners profit margin. The profit would be determined in general figures using the market status. Mr. Bartholomew responded to Representative Brown's concern, noting that the Department of Revenue (DOR) has provided an analysis of the Ward Air case. The State has the authority to charge an excise tax on fuel whether it is used on domestic or foreign flights. The State does not believe that they have the ability to do that in a Foreign Trade Zone or with bonded fuel. Preemptions exist in federal law. To date, the Department of Law (DOL) has not yet issued an opinion regarding that concern. Representative Navarre inquired about the cost sold of the fuel barged into Alaska. Mr. Bartholomew explained that the posted price and the contract price differs. That information as determined by the market, is part of a confidential agreement, and is not available to the State. Although, a wholesaler is required to report to the State the number of gallons received and the price paid. Co-Chair Hanley asked if Tesoro brought in fuel. Mr. Bartholomew replied that Tesoro was involved in the process of bringing in fuel, but he did not know the extent of their involvement. Tesoro produces and imports domestic jet fuel for sale to their customers. Representative Therriault disagreed that passage of the legislation would shield in-state refineries from competitive forces. He added that everyone was paying the tax except the foreign source. He felt that was unfair. Co-Chair Hanley pointed out that if the 3.2% tax was removed, both the refineries in-state and out-of-state would share the same competitive advantage. He thought the playing field would continue to grow. DAN SAVAGE, (TESTIFIED VIA TELECONFERENCE), FAIRBANKS, spoke in opposition to the legislation noting the loss of State revenue. Representative Therriault interjected that the revenue for the State would be lost regardless. TIM ROGERS, (TESTIFIED VIA TELECONFERENCE), LEGISLATIVE PROGRAM DIRECTOR, MUNICIPALITY OF ANCHORAGE, ANCHORAGE, confirmed that the municipality would be meeting next week with State officials in order to come up with another solution to the problem. He reminded Committee members how 9 important Anchorage International Airport is and how highly competitive the environment is in which it operates. He requested that the Committee provide oversight to enable continued operations of the fifteen carriers while at the same time, attracting new carriers. He emphasized the importance of not stifling free trade competition within the airport. Representative Therriault listed other factors which bring business to the Anchorage Airport. He pointed out the time constraints on operations of the airports within the Pacific Rim. He emphasized that Anchorage is strategically located so that international airlines can fly to the Pacific Rim sites before those airports are closed. RICHARD CURTIN, GENERAL COUNSEL, PETRO STAR, ANCHORAGE, spoke in support of the legislation. Passage of the bill would not result in lost revenue for the State. The carriers have the capability to bring in bonded fuel, and Petro Star believes that they will do so. Mr. Curtin stressed that the Administration's attempt to "level" the playing field will be a gamble. He recommended that the State do everything that they can to make Alaska attractive to foreign traffic. Mr. Curtin encouraged the Committee to opt to exempt "made in Alaska" fuel from the tax as long as foreign fuel was exempt. Co-Chair Hanley questioned the tax margin advantage. TRENT CARBAUGH, DIRECTOR OF JET FUELS, PETRO STAR, ANCHORAGE, stated that prices change every week. They are determined by the Los Angeles market each day. Contract agreements exist with each airlines. Those prices are fixed at the beginning and hold for the duration of the contract. Changes are based by many variables; it is impossible to estimate the tax margin percentage. Co-Chair Hanley asked if foreign fuel had to be imported as bonded fuel. Mr. Curtin stated that it did not. Co-Chair Hanley understood that the reason that airlines continue to do it, is that the bonded fuel would provide exemption from the tax. He thought that there would be costs associated with the bonding. He added, should the tax be eliminated, there be a need to bond. Mr. Curtin pointed out that Mr. Stark indicated the average costs of bonding fuel was less than 1/10 of one-cent per gallon. Co-Chair Hanley understood that the cost was the difference of commingling within the FTZ and the bonding. He reiterated that FTZ is not the issue; the concern appears to be the bonded fuel. Co-Chair Hanley requested Commissioner Perkins to provide further information regarding the bonding costs paid by the 10 oil companies; he asked if those costs would be changed with removal of that tax. Mr. Curtin advised that the major portion of the bonding cost resulted from the segregated storage. Representative Navarre questioned if the bond requirement was increased or if the tax was reduced, would the in-state refineries then have a 3.2 cent cushion. Mr. Curtin said they wouldn't. That cost could not be beaten and would most likely eliminate the in-state refinery out of the market. Every gallon brought into Alaska would become a gallon of fuel cheaper than refined in Alaska. Representative Navarre reminded Mr. Curtin that currently suffer from periodic fuel shortages. Mr. Carbaugh informed members that more fuel will be imported into the market. That imported fuel has an advantage over the in-state refineries. Prior to FTZ operation, the only fuel that was imported, was the additional volume that the in-state refineries could not make. From this point forward, as long as a situation exists, the air carriers will be checking the volumes which they utilize for the inbound portions of the originating foreign flights. That fuel would have to be FTZ bonded fuel. (Tape Change, HFC 96-68, Side 1). Mr. Curtin said that governments everywhere try to design their tax policies to favor industries. Representative Navarre reminded Mr. Curtin that the playing field is not "level" yet. He suggested that transportation costs will impact the market concern. He thought that the legislation could provide an additional profit advantage. Mr. Carbaugh countered that the market has been set previous to the tax issue. There are many times during the year that the imported price will beat the Los Angeles price product. He pointed out that is what creates the market and also creates the commodity. Mr. Curtin reiterated that Petro Star favors the legislation and that they would like to see the FTZ left in tact. He thought that the only other politically feasible solution would be to address the FTZ. Petro Star would support that action in as much as it "levels" the playing field. Representative Martin asked if capacity exists within the State to supply our fuel needs. Currently, Mr. Carbaugh said that the three oil companies are able to supply the bulk of the needs to Anchorage. However, there are other refiners on the West Coast who import product. They would also be affected by the tax. The benefit of using the FTZ 11 is to commingle the product. That then allows the airlines to avoid customs provisions in segregating and bonding fuel. That solution would cause additional management and capital costs. He concluded that removing the FTZ would only create animosity with the airlines. Representative Therriault spoke to the loss of the $4.2 million dollars. He noted that the Department of Revenue's fiscal note indicates a current loss of $700 thousand dollars. The airlines are moving aggressively to shift their fuel source. He thought that the $4.2 million dollars would be lost regardless. Co-Chair Hanley requested Commissioner Perkins to provide information regarding the problem of the bonded fuel. Representative Brown inquired where Petro Oil purchased their crude oil from. Mr. Curtin replied that they purchase it from a producer on the North Slope, and that cost was based on a sale price determined outside the State. Representative Brown questioned if the margin received by the Alaskan refineries was a reasonable percentage compared to what they charge the public. Mr. Curtin advised that was confidential information. TOM JOHNSON, SELF, JUNEAU, questioned at what point does the State stop trying to meet the potential price decreases and at what point does the state protect the in-state refining capability. He asserted that repealing the tax will not help matters. The playing field is not level. He added that on the international scene, the Organization of Petroleum Exporting Countries (OPEC) cartel has been famous for cheating on their quotas. Mr. Johnson concluded that when it comes to profit, anything goes. JEFF COOK, VICE PRESIDENT, EXTERNAL AFFAIRS AND ADMINISTRATION, MAPCO PETROLEUM, ANCHORAGE, voiced appreciation with the Administration in trying to "level" the playing field by working with the Municipality of Anchorage to find a solution to the inequity. He voiced his concern regarding the bonded fuel issue. Mr. Cook stated that HB 362 would solve both the bonding and the FTZ issue. Alaska refiners do not provide enough jet fuel, and supplemental fuel is imported from the West Coast. He added that it does not appear that there will be enough fuel produced in the future, thus, forcing a competitive price. Representative Martin asked if MAPCO finds the FTZ beneficial. Mr. Cook stated perhaps in the future. He added, HB 362 does not tamper with the FTZ. Representative Martin voiced his support of free enterprise. Co-Chair Hanley commented that assumptions appear to drive 12 many of the decisions on the part of the oil refineries. Revenue will be lost with fuel being used on flights not being taxed. Co-Chair Hanley suggested that the other issues of profit margin differ. Representative Brown inquired if the product line-up could be switched. MIKE SMITH, ALASKA MANAGER, WHOLESALE MARKETING, DISTRIBUTION & SUPPLY, MAPCO PETROLEUM, ANCHORAGE, replied no. MAPCO's refinery at North Pole, Alaska, is a simple distillation refinery. Mr. Cook added that MAPCO refines approximately 43 thousand barrels a day and that 48% of that is jet fuel. HB 362 was HELD in Committee for further consideration.