Presentation by AOGA and AOGCC on HB 3001, HB 3003, HB 3004  JUDY BRADY, EXECUTIVE DIRECTOR, ALASKA OIL AND GAS ASSOCIATION (AOGA), stated that all three bills raise taxes on the oil and gas industry, but are very different. Ms. Brady highlighted the changes and policy issues of each piece of legislation. She read as follows (copy on file): NB 3003 and HB 3004 are tax bills introduced for the first time in this special session. Both proposed bills go back to the present production tax - and add some new twists, in order to increase taxes; HB 3004 adds complications to the present tax system, and raises policy issues that are arguably outside the call of this special session; both are strictly tax increases on the gross production at a level that fails to address the critical need for Alaska to attract new investment at the same time as the state's share in oil revenues increases. You have heard us say many times that declining production is the eight hundred pound gorilla in Alaska's future. Tax legislation must be configured to attract the new investment necessary to increase production. Incentives for new investment and reasonable tax rates that keep Alaska competitive with like oil and gas regions must be part of the package. Any legislation that overreaches on tax rates or neglects real world incentives will simply be a black hole that leaves Alaska as a backwater in worldwide oil and gas regions. There are now l4 days left in this special session - and four tax bills on the table. HB 3003 and HB 3004 you've just been hearing. HB 3005 was introduced two days ago. We understand two other bills are being drafted. Of the four tax bills presently on the table, only one has been the subject of long and intense review and scrutiny - and that is HB 3001, the Petroleum Production Tax legislation. The PPT legislation was the subject of hundreds of hours of hearings in the last legislative session and in the last special session. It has been reviewed and critiqued by consultants hired by the legislature, the administration and the oil and gas companies affected. The parameters of this legislation are well understood. We ask you to consider focusing the remaining days in this special session on reviewing, finalizing and adopting HB 3001. The fact of the matter is that developing clear, fair tax legislation that both incentivizes investment and brings a larger share of revenue to the state is rocket science. Those of you who have spent hundreds of hours trying to develop fair, equitable legislation, are well aware of this fact. Rocket science takes time and so does tax legislation. The legislature has spent that time on a new approach for oil production tax in Alaska - a tax that reflects real production economics. A tax that substitutes real cost figures for the proxy Economic Limit Factor. The promise is that this tax will increase revenues to Alaska by over one billion dollars a year. The promise is that in addition to increased revenues, this tax will provide incentives for new investments for the new production so desperately needed. AOGA Supports HB 3001 - Governor's PPT • Even though many of our members remain concerned that the increased level of state take reflected in this bill will result in reduced investment in Alaska. This bill would raise taxes on the industry over $1 billion a year at $60/bbl. • There continues to be a sense of astonishment in oil and gas financial circles about this agreement to a tax increase of this size. • And would raise total government take to around 60%. • "Government take" - royalty; production tax, corporate income tax; property tax, federal taxes • What do "costs" have to do with it - costs have to be counted either directly or as a proxy to conserve oil in the ground in maturing fields • PPT more accurately reflects true production economics • The balance in the PPT is the higher tax rate counterbalanced by the reinvestment incentive. • The balance is essential - throughout the hearings on PPT there have been references to countries with a "higher" government take than Alaska - as Pedro Van Muers and other consultants have pointed out, many of those countries either have government-owned oil companies or are using production sharing contracts. In both cases the governments take a bigger share of risk for a bigger share of profits. • Some policy makers seem to be frozen between the concepts of "risk" and "profits". They want a lot more of the share of the profits; they don't want any share of the risk. • This one-sided "two for me - one for you" won't work in the worldwide competitive market. Under those terms, Alaska's won't even place for new investment in any serious way. Gross Versus Net tax - Criticisms of a net system seem to be based on a misunderstanding of how the present system works and how the PPT would work. • The ELF in the current system is a proxy for costs. So in that sense the current system is a form of "net" tax. The PPT simply substitutes real costs for the proxy. • Some legislators have expressed the concern that the state does not have the capability to determine real costs. However, the state currently audits the costs in the netback in a lot of detail. • Operating and capital costs are in our state income tax return and property tax renderings. 11:19:22 AM MIKE HURLEY, CONOCOPHILLIPS ALASKA, CHAIR OF AOGA TAX COMMITTEE, spoke to auditing. Every return filed by the oil companies is audited. The audit assessments over the past several years have been within 2% for what is anticipated payment. He reiterated that it is a 100% audit. 11:21:04 AM Ms. Brady said she knew that the Department of Revenue has the capability to audit. She addressed previous court cases surrounding the production tax and prevailing value. Currently, the state has been through all necessary steps for a net production tax. Ms. Brady continued with her presentation: AOGA Does Not Support either HB 3003 or HB 3004 • These bills are simply tax increases with no counterbalance • No re-investment incentives, do nothing to stem decline or encourage investment, there's no structural change in the risk sharing. • With HB 3003 ELF disappears so there's no recognition of costs at all. • HB 3004 is a band-aid approach - a higher rate, with much more complexity. It seemed puzzling that the sponsor spent so much of his time providing figures about the industries profits, yet was proposing a tax that has nothing to do with the profits. Oil and Gas Tax Legislation Is Not a Game of Texas Hold 'Em • Whether it is political one-ups-man-ship during an election year - or real belief that Alaska does not have to be competitive to attract new investment - the bidding up of how much the state of Alaska can "make" or "take" from oil production is going to lose the game for all of us. The end game for oil and gas tax legislation can be about a higher return for the state of Alaska but must recognize the need for incentives that foster additional investment - bottom line - It is about increasing production and keeping Alaska competitive. The pipeline is only half full. This must be turned around. 11:25:22 AM Mr. Hurley addressed access. He maintained that access has not been denied. 11:26:18 AM REPRESENTATIVE LES GARA commented on the access issue. He asked if ConocoPhillips' facilities had been made available to small producers. Mr. Hurley replied that a company called Windstar made use of ConocoPhillips' facilities but came up with a dry hole. He stated that there has been no production loss. Representative Gara clarified that no other independent company has been able to produce oil through ConocoPhillips' facilities. 11:27:58 AM Representative Gara wondered why, in spite of an increase in profits, exploration and investment have not increased. Ms. Brady replied that in the years when the oil company profits increased, so did the state's. As far as further investment, ConocoPhillips is investing "big time" this year. There are more wells being drilled. She did not know the investment figures, but thought all investments had increased. Exploration doubled during that time period. There is money going to investors in dividends and the Alaska Permanent Fund benefits from that; there is money going to investment; and there will be more buy outs. Analysts look at the reserves, which need to be explored or bought. 11:31:32 AM Co-Chair Meyer commented on the only common ground found in the net versus gross debate, which is to increase investment and production. He asked if the net would help meet that objective better. Ms. Brady replied it would; net is based on profit. Net only, without incentives, would not work and would be dangerous. Under the net tax, the state takes a bigger risk through the incentives, and the companies can afford to take less profit at the top. She concluded that she prefers the net. Co-Chair Meyer asked how to attract more oil companies to Alaska. Ms. Brady replied that the fiscal system is the only thing that the government can control. Shell Oil is coming back into Alaska and other companies are showing an interest. The state needs a big find. 11:34:57 AM Co-Chair Meyer asked if AOGA represented all oil companies in Alaska. Ms. Brady replied that it represents all 18 companies. 11:35:21 AM Co-Chair Chenault addressed a question about Prudhoe Bay to Mr. Hurley. He wondered what paper work would be required to allow for "gaming" of the system. He did not envision a scenario that the auditors could not work through. The state can audit for any detail and the level of auditing would be a choice made by the state and the legislature. Co-Chair Chenault speculated that it would take all three companies to successfully "game" the state. If that was done there could be jail time and fines. Mr. Hurley agreed. Co-Chair Chenault thought that there were protective mechanisms in place. 11:39:09 AM Representative Kerttula stated it wouldn't be collusion; there could be disagreements with the state over the rightful costs, which could result in court cases. Mr. Hurley recalled that there was a past case settled regarding tax costs. Representative Kerttula added that she has been involved in tariff cases regarding disagreements. She spoke to her history in the Department of Law. She disagreed with the usage of "fraud". Mr. Hurley noted that AOGA submitted comments on the Governor's PPT bill requesting clarity on excluded costs. There are concerns by the companies. 11:41:23 AM Representative Kerttula foresaw problems with costs when giving substantial weight to the agreements. She encouraged that a standard be established. She emphasized it is not a collusion situation. 11:42:28 AM Ms. Brady pointed out that there is competition on the North Slope. Each company thinks their way is the best. Over the past 40 years, the state has had access to the disputed information. Many issues have already been worked out. Mr. Hurley pointed out grouping of costs, with 3 to 4 different conceptual models: * Inter-company billing * IRS reference to ordinary and necessary * DNR regulations for net profit sharing exclusions 11:45:42 AM CATHY FOERSTER, COMMISSIONER, ALASKA OIL AND GAS CONSERVATION COMMISSION (AOGCC), read from her prepared testimony (copy on file.) Before proceeding, I want to disclose to you that, immediately prior to serving on the AOGCC, I worked as an engineering consultant and, as such, I participated in preparing the "North Slope of Alaska Facility Sharing Study" performed by Petrotechnical Resources of Alaska for the Division of Oil and Gas of the Department of Natural Resources. I discussed this participation with the other AOGCC commissioners and they agreed that this did not represent a conflict of interest. However, I did want to disclose the information to you. The AOGCC recognizes the need to enable new operators to acquire reasonable access to existing facility infrastructure. If the Legislature adopts HB 3004, the AOGCC will do our best to implement it. That said, there are a few challenges to implementing this bill as it is currently written and, if you'll bear with some technical description from me, I'll explain what those are with some suggested ways around them. The bill requires working interest owners to provide access to production or other facilities "only if the commission finds that the facility has excess capacity and that directing the working interest owner to provide access by or for the benefit of others would not materially interfere with the owner's paramount use of the facility." The AOGCC has two concerns with this wording. First, there will never be excess capacity in the oil production facilities that this bill is targeting. 11:49:52 AM Representative Gara related that he does not dispute the excess capacity issue. The question is if new facilities should be expanded and the costs charged to the company. Ms. Foerster explained the capacity design by providing the history of oil, gas, and water in various fields. She used the example of expanded facilities and no excess capacity. The gas and water continue to increase, but not all oil produced can fit into the facility, which becomes a problem. She showed a hypothetical situation where Tarn comes in with 10,000 barrels and where that same amount must be taken out to provide room. Each well takes a priority ranking and the bottom wells get "backed out". There is no cost at this point to get into the facility. 11:57:16 AM Ms. Foerster discussed how a new player with 10,000 barrels of oil would enter the market, backing out 9,000 barrels of water and 1,000 barrels of water. The cost to get in would be the sum of lost revenue and profit. The costs are very clearly spelled out in the DNR study. The lost area costs are debatable. The third issue concerns what a fair profit would be. Negotiation would have to take place. 12:00:59 PM Co-Chair Meyer asked if the process would scare off new producers. Ms. Foerster said her opinion is that people assume that there is a monopoly going on. She suggested talking to Windstar who negotiated with ConocoPhillips. Co-Chair Meyer commented that that was a dry hole. Ms. Foerster maintained that the negotiation process was held and was valuable. 12:03:19 PM Ms. Foerster continued to read from her handout: Even if we get past the "excess capacity" wording, there is a second complication. Since the owner's paramount use of the facility is to separate the associated gas and water from their oil, any back out for another operator would interfere with their "paramount use of the facility." Supposing that we work our way past these two concerns, let's next take a look at the fiscal impact. First, a primary role here is a rate-setting role, and the AOGCC has no staffing or experience in rate setting. Therefore, to take on this rate-setting role we would have to hire accountants and/or other financial expertise. Second, we would need someone on staff who understands and can oversee facility optimization; we currently have no one on staff to perform that function. 12:05:02 PM We have one final concern with placing this authority within the AOGCC. And that is the potential for conflict with the AOGCC's role implementing the Oil & Gas Conservation Act. The commission is charged with preventing waste, ensuring greater ultimate recovery, protecting correlative rights, and protecting ground waters. Decisions under this bill may be in conflict with the commission's responsibility to prevent waste of hydrocarbon resources and ensure greater ultimate recovery. For example, granting access to a production facility for one WIO's high-oil-rate well may result in the permanent loss of oil from the WIO whose marginal well is backed out of the facility. Our recommendation would be to give this rate-setting responsibility to either a new or an existing agency that is intended as a rate-setting agency. I want to conclude by reiterating what I said first: The AOGCC recognizes the need to enable new operators to acquire reasonable access to existing facility infrastructure, and if the Legislature adopts HB 3004, the AOGCC will do our best to implement it. 12:07:05 PM Co-Chair Chenault suggested Representative Gara and AOGCC meet to discuss the issues and work out their differences.