SENATE BILL NO. 305 "An Act relating to the tax on oil and gas production; and providing for an effective date." 1:46:04 PM Co-Chair Hawker explained that SB 305 addresses the decoupling of oil from gas as related to the oil and gas production tax and the interplay of the issue with Alaska Gasline Inducement Act (AGIA) legislation in the forthcoming open season. He reported that the bill had been thoroughly vetted on the Senate side with a lot of technical analysis and that the bill had also been carefully reviewed in the House Resources Committee. Co-Chair Hawker stated his intent to accomplish the mission of the sponsors. He anticipated a difference of opinion from the administration on the necessity of passing the bill. He outlined his plan for the bill in the House Finance Committee. 1:50:55 PM SENATOR BERT STEDMAN, CO-CHAIR, SENATE FINANCE COMMITTEE, SPONSOR, provided an overview of the history of the legislation. His initial concern was looking at the issue from a fiscal position and determining that the state was potentially at a fiscal disadvantage at the level of billions of dollars. He recognized the difficulty of communicating the magnitude of the fiscal challenges. He explained Senator Paskvan's role as a legal advisor on the legislation. He believed Senator Paskvan had the advantage of entering the legislature after the discussions on the Petroleum Production Tax (PPT), Alaska's Clear and Equitable Share (ACES), and AGIA; he believed a fresh eye would be helpful. 1:54:13 PM Senator Stedman referred to the time when the state functioned under the Economic Limit Factor (ELF) or tax and royalty regime and was transitioning to a production- sharing arrangement. He noted that North America is basically structured under the tax and royalty approach and most of the global hydrocarbon basins have production- sharing or profit-sharing arrangements. He recalled that after extensive legislative review of the ELF structure, the fiscal regime of Alaska was restructured to production sharing. He noted that months were spent in the legislature adjusting the new structure, especially related to progressivity. The royalties had been left in place; however, it became clear that the share going to the state would decline when the price of oil went from $60 to $80 per barrel. Concern about the decline led to progressivity, an added tax that would protect the state when oil prices were high. The decision had been made to stop the PPT at $60 per barrel; in hindsight that was too low. There was debate about progressivity. Senator Stedman referred to negotiations for a gas line under the Murkowski administration and a proposal to take 20 percent of the gas (12.5 percent of royalties plus 7.5 percent severance), own 20 percent of the pipe, have a 20 percent capital credit, and a 20 percent base tax. The base tax was increased to 25 percent. At the time, there was no gas to speak of. Cook Inlet was separated from the discussion as an old, declining basin; the new tax regime did not apply to it. The only gas in the state was in Cook Inlet and in the Arctic. The gas field in Prudhoe Bay was going to be taken in-kind. All of the focus of the discussions at the time was on oil. Gas was intentionally set aside. 1:58:09 PM Senator Stedman continued that adjustments were made through ACES and AGIA; the 20 percent ownership in pipe and the 20 percent ownership in gas fell away. However, the gas tax structure was still left in place. Senator Stedman underlined that the legislature had structured progressivity around oil. He described gas as a lower-valued hydro-carbon; oil produces six times more energy per volume than gas, and is eight or ten times more valuable. In the eight to ten range there is not a lot of impact on the fiscal regime. There has been a structural change within the economy and the energy world in the past three or four past years. Vast supplies of natural gas have been discovered globally, lowering the pressure on gas, while upward pressure has been put on oil. Currently, oil is valued at about $80 per barrel and gas is at $4, a 20 to 1 ratio. Senator Stedman relayed that a couple of years ago, the Legislative Budget and Audit Committee found a consultant to make a mathematical model of Prudhoe Bay, Kuparuk, and Alpine fields so that the legislature could measure and evaluate a potential gasline proposal. He had requested that the consultant review the oil tax structure and the gas tax structure and measure the offset (or subsidy or dilution) resulting from large gas volumes and oil volumes; the total revenue was going down instead of up. Senator Stedman referred to a March 2, 2010 memorandum from Dr. David Wood, a consultant to the legislature (copy on file) calculating the impact over the past couple of years. Dr. Wood had presented his findings to the House Resources Committee. Some believed the policy implications were huge and asked for a presentation before the Legislative Budget and Audit Committee. Senator Stedman reported that he had become greatly concerned about Dr. Wood's analysis of the dilution effect in terms of the fiscal impact to the state but also about the lack of recognition in the legislature of the potential impact. He emphasized that the mechanism is extremely complicated and the numbers are unbelievably large. Senator Stedman continued that the AGIA open season came around and Mr. Tony Palmer from TransCanada came before the legislature to discuss potential costs of a mainline pipe. Mr. Palmer referred to estimated tariffs and price expectations. 2:03:50 PM Senator Stedman maintained that under the AGIA terms the state faced a contractual obligation to lock in the gas tax by May 1, 2010. He noted that the state has the ability to adjust oil tax up or down, but not gas tax. Senator Stedman explained that the Senate Finance Committee had spent several weeks studying the information available, starting with the basic structure of the oil and gas tax. Oil was covered in the first week and then the hypothetical 4.5 billion cubic feet per day (Bcf/day) gas model. He underlined that the conclusions were "not pretty." The administration did a review as well, but their numbers were not any better. Senator Stedman emphasized that the state had a good revenue stream with oil, but when oil is 15 times more valuable than gas, the total dollars to the treasury went down with gas. He was alarmed that the state has spent thirty years waiting for a gas line and a strong gas economy, when it was clear that without gas revenue, there would be no gas economy. Senator Stedman pointed to current numbers, stressing that what matters is the relationship between oil and gas prices. With oil standing alone, the state would make $8.6 billion; with gas, the state would make $330 million. Noting that the progressivity calculations are based on 30 days, with 30 days before first gas at ten to twelve years out, the revenue stream would be $8.6 billion (annualized over 12 months). Given that number, the legislature might work the budget details. 2:08:22 PM Senator Stedman continued that first gas could come, and thirty days later the state might find out, for example, that the same volume of oil (500,000 barrels) was being pumped and gas was flowing well, but the revenue would then be only $5.2 billion. He warned that under the example, the state could suddenly lose $3.4 billion and make only $330 million in gas. The net loss could be $3.1 billion. The gas line would have to be shut down and there would be serious budget problems. Nothing could be done because the state would be under contractual obligation for the following ten years. Senator Stedman questioned how the legislature could answer to future generations for such a significant loss after waiting thirty to forty years for gas to flow. He commented that he and other legislators had traveled throughout Canada and the United States to energy conferences and looked carefully at the models. There had been consideration about how to incentivize an oil basin, including adjusting progressivity, production-sharing, and base tax numbers or shifting property taxes for things like a gas treatment plant. Senator Stedman stressed that the Arctic has a world-class oil basin. He argued that the state was not creating an incentive, but giving away revenue at a "staggering" magnitude. For example, the state could build a $100 million road to encourage drilling and exploration or build a port at Anchorage for several hundred million. He did not want the state to give away billions of dollars year after year. Senator Stedman suggested buying equity in a project, such as buying 10 or 20 percent of the pipe, so that the state would make the 12 or 13 percent regulated rate of return rather than handing the cash to others. Senator Stedman emphasized that the problem was the quickly approaching lock-down date on May 1, 2010, the first day of binding open season. 2:14:04 PM Senator Stedman warned that the magnitude of the problem is so severe that if AGIA succeeds and the first binding open season succeeds, the industry could lock the state down and it would be "game over." He pointed out that the only leverage the state has left is oil, if gas cannot be moved. He argued that politically, oil taxes could not be raised by one third (the amount required to make up the gap in the previous example). Compared to other structures around the world, he believed the current tax structure in Alaska is a burden. He felt that the state was currently giving its oil away and that oil revenue had to be protected through adjustments and incentives, and the gas pipeline had to be made competitive and attractive. Senator Stedman stated that he did not want the legacy of giving away the state's oil. He noted that the state can legally decouple at any time, but he argued that if it is done before May 1, 2010, there would be less fiscal risk than waiting until after the date. He thought the state could gamble that the price of gas would go higher than the price of oil, but he did not think the projections supported such a gamble. He believed there would be higher- valued oil and lower-valued natural gas because of the amount of gas available. 2:18:43 PM Co-Chair Hawker stated for the record that he agreed with the problem identified by Senator Stedman. He relayed that he had participated in the discussions about PPT, ACES, and AGIA. In 2006, there was a session during which the new proposal for the profit-sharing production tax was vetted. He noted that it had been universally appreciated that the ELF had become outdated and needed to be replaced. A special session was called where the debate continued. During the interim between two special sessions, he and others met to consider the deadlocked bill; the "producer pay plan" was crafted as an evolution of the profit-sharing production tax involving an incentive to lower tax rates for producers increasing production. Co-Chair Hawker continued that the new bill made it through the House and was fine-tuned by the Senate; the producer pay plan developed into the profit-sharing production tax (PPT). The bill was crafted in his office with the Department of Revenue (DOR) to address the oil ELF, but as time passed, it became clear that the gas ELF also needed to be addressed through a different formula. He witnessed that the crafters of the legislation had believed they did not have to worry about the gas tax for another 15 years. They understood that it would be complex to structure both a new tax on oil and on gas and decided to put them under the same tax regime, although there was a different price structure on oil than on gas; one was sold by the barrel and the other by thousands or millions of cubic feet. In addition, there was a significant value difference. The same tax rate could not be put on the different values. Co-Chair Hawker recalled that the crafters came up with the idea of the British Thermal Unit (BTU) equivalency formula. However, that would work only if the BTU equivalency was the same as the price equivalency. They knew that combining low-value gas and high-value oil would result in a diluted tax structure, but knew also that there would be 15 years to deal with the problem. 2:23:13 PM Co-Chair Hawker noted that the progressivity feature added by ACES exacerbated the problem as it triggered profound value differences. Next, AGIA was passed and provided "fiscal certainty" for the players: the gas-production tax would be fixed at the start of the first day of the binding open season. The lock-in provision based on the start of the first open season suddenly reduced the 15 years they had previous assumed they had to 15 months. He admitted that when AGIA passed, he had not made the connection that the time would be shortened. Co-Chair Hawker agreed that on May 1, 2010, the state would be locked in to the gas tax structure for ten years. He emphasized that the crafters of the structure had not intended the outcome. SENATOR JOE PASKVAN informed the committee that he had arrived at the same conclusion as Senator Stedman regarding the need for decoupling gas and oil. He had begun by reading the AGIA statutes to understand the extent of the lock-in that the state was facing on May 1. He had reviewed the opinion of Attorney General David Marquez and his analysis under the Stranded Gas Development Act of the risk to the state of Alaska. Senator Paskvan reported that he had called the current Attorney General Dan Sullivan two months ago and told him he believed there was a tremendous risk and that he was not legally comfortable with. He emphasized that the legal issues were complex. He thought the number one issue before the current legislature was the fiscal issue. He agreed that the magnitude of the problem was so great that it could result in Alaska giving up 100 percent of any production tax on natural gas and 100 percent of its royalty. The state would have to use oil savings while the gas flows. 2:27:57 PM Senator Paskvan stressed that the monthly analysis of the situation was that Alaska would be bringing in about $725 million per month in the first 30 days before the 4.5 Bcf/d of gas flows; after the gas flows, the state would receive less than $500 million per month. Hundreds of millions of dollars would be lost each month. He called the situation a "third-world resource extraction model" where the state would pay while the resource leaves the state. Senator Paskvan argued that decoupling gas and oil would result in absolutely no increase in oil tax and that the trigger point at 25 percent and the slope of progressivity would remain the same. The gas tax would remain the same, at 25 percent with the same slope of progressivity. The state would be protected if gas became more valuable than oil. Senator Paskvan underlined the conclusion that decoupling is necessary. He added that the only other issue before the legislature was the question of the methodology of determining the gas production tax obligation specifically referenced in AGIA statute Section 320. He referred to a presentation by DOR Commissioner Pat Galvin to the Senate Finance Committee. Commissioner Galvin had used the point- of-production tax (the system put in by regulation 15, AAC.90.220) and arrived at a gas production tax obligation of $1.2 billion. Decoupling and using a point-of-production analysis, using the same structure used by the commissioner would allocate 78 percent of the cost to oil and 22 percent of the cost to gas. The tax obligation on a decoupled basis would be approximately $1,015,500. He stressed that that is the beginning point for negotiation. Senator Paskvan concluded that the state should keep its eye on the top line for gross revenues for both products on a decoupled basis and then look at the negotiation position by making sure that the starting point is at the billion dollar range. Co-Chair Hawker noted that SB 305 was the proposed solution and would be presented by the consultants. 2:32:18 PM Representative Gara commented on the difficulty of shifting ideologies without preconceptions. He noted that with some language changes he might agree with the senators and Representative Hawker. He pointed out that he had been present throughout the PPT and ACES debates and had not been told once that Alaska could have a gas pipeline and a oil pipeline that produced less revenue than an oil pipeline alone. He believed the issue was very important. Representative Gara stated that he, Senator Hollis French, and others had tried to push for separate oil and gas taxes and were told that it could not be done. He wanted to enter into gasline negotiations from the strongest position possible. He listed previous concerns that had been addressed, including that it made sense to leave progressivity in. He had committed to let industry deduct gas field costs from oil taxes in order to move a gasline forward, and he thought it would be wise to craft language so that the small amount of gas produced on the North Slope would not have to be burdened with decoupling in the meantime. Vice-Chair Thomas stated concerns about the timing of the legislation; he worried that the House would not have the time with the legislation that the Senate had. He agreed that the issue was huge. He did not want to lose money, but he wanted more information about the gas taxes and urged proceeding with caution. 2:37:34 PM Senator Stedman pointed out that currently there was cross- subsidy going on as there was gas in the Arctic and Cook Inlet as well as Prudhoe Bay-Kuparik, but emphasized that SB 305 was revenue-neutral. He recalled that in the last three years the impact to the treasury has been roughly $250 million without gas. There was language in the bill to protect the industry so they would get the current dilution. The crafters did not want to "rock the boat"; they wanted to protect the state from being locked in on May 1. Co-Chair Stoltze emphasized the importance of the May 1, 2010 date and the consequences of the administration deciding not to sign the bill. Senator Stedman agreed regarding the importance of the date. Co-Chair Hawker reported that the administration had testified that it views the problem as less severe. Vice-Chair Thomas queried what could happen if the governor vetoed the bill. He wondered whether the legislature could override the veto in time. Senator Paskvan did not know. He believed the effective date on the statute was January 1. Co-Chair Stoltze hoped there would be more testimony related to the importance of timing. 2:42:07 PM AT EASE 2:42:22 PM RECONVENED Representative Fairclough believed there was time before May 1 to fully understand the issue. Co-Chair Hawker pointed to extensive testimony and analysis on the bill's website. ROGER MARKS, PETROLEUM ECONOMIST, LEGISLATIVE BUDGET & AUDIT COMMITTEE, introduced himself and his partner as being from Logsdon & Associates and under contract with the Legislative Budget and Audit Committee to assist the legislature in gas taxation matters. Co-Chair Hawker queried their qualifications related to oil and gas issues. Mr. Marks replied that they had worked for the Tax Division of DOR for many years on the oil and gas production tax and issues of gas commercialization. CHUCK LOGSDON, PETROLEUM ECONOMIST, LEGISLATIVE BUDGET & AUDIT COMMITTEE, added that they had over fifty years of experience between the two of them in evaluating petroleum taxation related to the Alaska fiscal system. Mr. Marks provided a summary of the premise and rationale for the bill and a description of how the bill works, using a PowerPoint presentation, "SB 305: The De-Coupling of Oil from Gas for the Oil and Gas Production Tax, Logsdon & Associates, House Finance Committee, April 14, 2010" (copy on file). He began with Slide 2, "Acronyms": BBL barrel BCF billions of cubic feet MMBTU millions of BTUs BOE barrel of oil equivalent Mr. Marks detailed that a barrel (bbl) is how the volume of oil is measured and the unit of how oil is sold. Billions of cubic feet (Bcf) refers to how the volume of gas is measured. He explained that natural gas contains mostly methane but also butane and heavier hydrocarbons; while the volume is measured in cubic feet, it is sold in terms of the millions of British Thermal Unit (BTU) content (MMBTU). Finally, the barrel of oil equivalent (BOE) puts gas on the same basis of oil so they can be added up, measured, and compared by converting MMBTUs of gas to bbls of oil. A barrel of oil has 6 million BTUs; taking the amount of BTUs of gas and dividing by 6 puts the gas on a barrel of oil equivalent (BOE). 2:47:29 PM Mr. Marks turned to Slide 3, "The Problem": • The progressivity part of the production tax rate is based on per barrel oil or per BTU gas profitability • Under current law oil and gas are combined for calculating the progressivity • Oil is worth much more than gas • With a major gas sale, combining the lower value gas with the higher value oil will "dilute" the per barrel oil profitability: - Driving down the progressivity factor - Materially reducing production taxes Mr. Marks detailed that there is currently a base tax rate of 25 percent on the oil and gas production tax; progressivity is added to that to give a higher rate if the value of the oil or gas is above a certain rate. Co-Chair Hawker summarized that when gas comes on the unit higher values of the oil are diluted. Mr. Marks reviewed Slide 4, "Oil vs. Gas Value": • Now: - Gas: $4/mmbtu - Oil: $80/bbl ($13/mmbtu) • Department of Energy forecast for 2020: - Gas: $8/mmbtu - Oil: $120/bbl ($20/mmbtu) • Transportation cost deductions: - Gas: $5.00/mmbtu to Lower 48 - Oil: $6.00/bbl ($1.00/mmbtu) Mr. Marks detailed that on a straight BTU to BTU basis, oil is currently worth about three times as much as gas. The U.S. Department of Energy forecast for 2020 (when it is hoped that a major gas sale would start) is $8/MMBTU, while the forecast for oil is around $20/MMBTU, or about 2.5 times as much as gas. In addition, in Alaska the differences are exacerbated by transportation costs. The tax is based on net value. Gas will have a much higher transportation cost than oil per MMBTU, about five times as much. 2:50:52 PM Mr. Marks directed attention to Slide 5, "How the Tax Rate is Determined": • Base 25% rate • Plus progressivity - Progressivity is based on the net value per BOE: • Oil Alone: Total oil value / Total oil barrels • Combined Oil & Gas: Total oil and gas net value / Total oil and gas BOE's - When lower value gas is added to the higher value oil the average net value of the combined oil and gas goes down  Representative Doogan asked whether part of the problem would be a lot of low-value gas compared to relatively less high-value oil. Mr. Marks responded that he was correct and suggested thinking of the relationship as a fraction with the numerator being the value and the denominator being the amount of production. Representative Doogan noted that a lot of the issue is related to the theory that there would be a lock-down when companies nominate gas during the open season. He asked whether the problem would be exacerbated as more gas is nominated. Mr. Marks responded that he was correct; the greater the difference between oil and gas value, the larger the problem, and the more gas there is relative to oil, the greater the problem. Mr. Marks turned to Slide 6, "Reference Case," or how the world might look in 2020: • Oil - 500,000 barrels per day - $120/bbl market price • Gas - 4.5 bcf/day - $8/mmbtu market price • Upstream costs - $2.2 billion capital - $2.2 billion operating 2:54:39 PM Co-Chair Hawker noted that the same reference numbers had been used in the previous committee. He asked whether the upstream operating and capital expenses were reasonable costs to anticipate. Mr. Marks believed the numbers were reasonable and consistent with current costs, adjusted for inflation plus additional costs that may occur with new fields like Pt. Thompson. Representative Austerman asked whether the 500,000 barrels per day was taxable oil. Mr. Marks agreed; the numbers are DOR's forecast for production in 2020. Mr. Marks moved on to Slide 7, "What Happens under Status Quo": • Oil taxes under status quo prior to gas production: Net value of oil = $86/bbl (tax rate 47%)  Oil Tax = $6.1 billion • Add a 4.5 bcf/day of gas: Combined net value of oil and gas = $47/bbl (tax rate 32%) Total oil & gas taxes: $5.5 billion • Bottom line: The drop in the tax rate of oil more than offsets all the the taxes on gas. Not only does the state not received any additional revenues from the gas, but oil revenues drop as well. Mr. Marks detailed that the numbers assume oil production similar to present levels and no gasline, 500,000 barrels per day and the $120 Lower 48 price. When the costs are subtracted to get to the net or production tax value, the net value is approximately $86/bbl. Given the way progressivity works, when the amount above $30 is subject to a 0.4 percent slope per dollar, the tax rate is 47 percent at $86/bbl. The tax rate would be $6.1 billion annually. Mr. Marks explained that adding a 4.5 Bcf/day gasline on top of the oil production would not affect oil; but combining the lower-value gas with the higher-value oil would reduce the $86/bbl average BOE value down to $47/bbl. Co-Chair Hawker asked whether the scenario would occur when the switch is flipped on and gas is produced. Mr. Marks agreed; the prices would occur when the average value of the oil is diluted by the gas. Without the gas, oil would have the $86/bbl tax value at 47 percent tax rate; switching on the gas would bring the combined value down from $86/bbl to $47/bbl (tax rate at 32 percent). Mr. Marks highlighted that the total taxes would then be $5.5 billion for both the oil and the gas. There would be no additional taxes from the gas and the oil revenue would drop as well. Mr. Marks reported that over the past months he and Mr. Logsdon had looked extensively at other international petroleum fiscal regimes. They could find no other place on the planet where a jurisdiction combines substances of different values and the basis for taxation is the combined per unit value. Co-Chair Hawker clarified that the comparisons referred to annualized numbers. Mr. Marks concurred, and emphasized that the $5.5 billion was the total taxes from the oil and the gas both, compared to the $6.1 billion that was oil alone. 2:59:11 PM Representative Kelly queried writing regulations [adopted by DOR during AGIA] related to changing the point of production and the BTU oil equivalent. Mr. Marks replied that he would get to the issue. Representative Doogan asked the value of gas in the example. Mr. Marks replied that the value of gas on a MMBTU basis would be about $1.60 and on a BTU basis $9 to $10. The dilution effect drags the oil taxes down and the gas taxes up, but the net effect is that the oil effect overwhelms the gas effect, which creates the drop in revenue when oil and gas are both being produced. Vice-Chair Thomas asked what would motivate a person who voted against ACES to vote for decoupling. Mr. Marks replied that the issue was a policy call. He stated as an analyst that whether a person liked ACES or not, it was the law of the land. He stressed that ACES would stay in effect just as it was passed except that it would apply to oil and gas distinctly. Co-Chair Hawker agreed that the question was on his mind as well. He reiterated that the crafters of PPT knew that the dilution problem would have to be dealt with. He believed the issue was a long-term consistency one and that SB 305 would "buy an insurance policy, just in case." 3:04:39 PM Representative Austerman asked for clarification about the numbers arrived at. Mr. Marks replied that the assumptions start with $86/bbl oil and the gas at $9 on a BOE basis and ends up with and average of $47 for per unit value oil and gas combined. Representative Austerman queried the value of the $8 when oil and gas are combined. Mr. Marks responded that the value was about $1.60. Representative Gara went back to Representative Kelly's question. He summarized that (related to valuing the gas) the Senate had passed a version on a BTU basis; the House Resources Committee worked with the administration and came up with a point-of-production basis for the value. Whether there is a BTU basis that results in a lower gas tax or a point-of-production basis that is higher, the goal is to not start the open season with a gas tax that is too low as it might only go lower with negotiations. He queried the regulations passed with a definition of gas taxes. He asked whether the DOR regulations would be overridden if SB 305 were passed. Mr. Marks clarified that there were two different issues. With decoupling, there would be the issue of allocating costs between oil and gas. The regulations adopted by DOR several weeks ago stipulate that under AGIA the gas part of the tax is locked in. Since under the status quo there is one total tax that does not separate gas tax and oil tax, the department needs to come up with a way to ascribe how much of the $5.5 billion is gas. Tax is being allocated, not costs, using gross value. He agreed that if SB 305 passed, the adopted regulations would not make sense. Decoupling would make clear how much the gas taxes are. 3:09:12 PM Representative Gara wanted assurance that Mr. Marks would work with the administration if SB 305 says that the regulations are no longer necessary. Mr. Marks thought the question was for the administration. Representative Fairclough summarized her understanding: the oil tax at $6.1 billion is an equivalent when taken into barrels; when the 4.5 Bcf/day gas is added, which will be taxed at the combined rate, the new combined rate equals the $47 per barrel (taxed at 32 percent). She asked the values of the oil and the gas. Mr. Marks replied that the value of oil has not changed. Representative Fairclough queried the difference in the tax rate. Mr. Marks replied that the tax rate on the $86 oil is 47 percent. Representative Fairclough asked for clarification. Mr. Marks explained that the tax went from 47 percent to 32 percent because of progressivity. Even though there is higher value for the oil, dropping the tax rate 15 percent on the total value accounts for the $1.6 billion less. Mr. Logsdon added that the weight average should come out to $47/bbl if the volume in barrels were multiplied by the barrel price for oil and the volume of the gas were multiplied by the barrel equivalent price of the gas. Mr. Marks elaborated that if the 4.5 Bcf/day on a BOE basis was divided by 6, the result would be about 750,000 BOEs per day; 750,000 BOEs of gas and 500,000 BOEs of oil, or a production ratio of 60 percent gas and 40 percent oil. Mr. Marks continued that the other side is relative value. He compared $86/bbl oil; at a BOE equivalent, the gas is about $9 ($1.66/MMBTU). He stressed that to put oil and gas on an equivalent basis, the $8 gas with transportation costs subtracted is worth about $1.66/MMBTU. 3:14:47 PM Mr. Marks turned to Slide 8, "What Happens with Decoupling [Using relative gross value to allocate cost]": • $120 oil and $8 gas - Status quo taxes = $5.5 billion - De-coupled taxes = $7.9 billion  $2.4 billion difference • Annual difference at other prices: - $100 oil / $8 gas: $1.4 billion - $80 oil / $8 gas: $0.8 billion Mr. Marks detailed that the difference between the status quo and decoupling would be around $2.4 billion. When decoupling, the costs need to be allocated between oil and gas. He referred to a recent amendment by the House Resources Committee to allocate based on the relative gross value of oil and gas (the gross value is market price less transportation). Using the gross value, the difference would be $2.4 billion between the status quo and decoupling. He noted that the bigger difference between oil and gas value, the bigger the difference between the status quo and decoupling. He covered the annual difference at other prices for oil. Co-Chair Hawker queried the break-even point. Mr. Marks replied progressivity is not linear. Co-Chair Hawker stated that the closer oil and gas come in price, there is less of a problem. Mr. Marks thought the question was how SB 305 would decouple oil from gas. Co-Chair Hawker contended that SB 305 is hard to understand and must be taken in context with the entire statute; he believed the presentation defined the simpler concept embodied in the bill. Representative Austerman asked whether the PowerPoint information was based on the amended bill coming out of the House Resource Committee or the Senate version. Co-Chair Hawker answered that the two versions were the same for the purposes of the current conversation; the major difference in the House Resources Committee version is an additional mechanism that would make the tax take effect for about three days, go away, and then take effect ten years in the future. The mechanism remained unchanged. 3:18:10 PM Mr. Marks asserted that SB 305 was changing one small thing in how the production tax works, which would make a big difference. He directed attention to Slide 9, "How SB 305 Works," highlighting the difference in calculation between the current tax regime and decoupling: • Currently - Each company calculates one statewide progressivity rate based on all combined oil and gas activity (oil, Cook Inlet gas, other in-state gas) • Under SB 305: Two Progressivity Calculations - Bucket 1: Same current activity (oil, CI gas, other in-state gas) will continue to be calculated together • No tax increase on current activity - Bucket 2: Progressivity on export gas will be calculated distinctly (same formula) • Will not dilute oil progressivity Mr. Marks detailed that currently there is one progressivity rate based on all combined oil and gas activity. Progressivity under SB 305, by contrast, would use two calculations, first separating current activity and export gas into two "buckets." Bucket 1 would contain all current activity; there would be no tax increase. Co-Chair Hawker stated that there would be no change in activity and no change in taxes. Mr. Marks continued that without SB 305, there would be only one statewide bucket and when a major gas deal happens, the gas exported would dilute the value of the oil. Senate Bill 305 would set up a new bucket (Bucket 2) containing only the export gas; progressivity would be calculated on the export gas exactly as it is calculated under ACES. He underlined that calculating the export gas separately would prevent the export gas from diluting the oil activity. Co-Chair Hawker summarized that the oil activity, calculated as it is currently would remain in Bucket 1, while the new export gas would be in Bucket 2 with a separate calculation. 3:20:54 PM Representative Gara asked whether gas that is not exported but used in the state would remain under the current ACES tax. Mr. Marks responded in the affirmative. Co-Chair Hawker noted that Cook Inlet gas would stay permanently under ELF. Mr. Marks added that it would be calculated under progressivity but would pay under ELF. Representative Austerman asked how "export gas" was defined. Mr. Marks replied that export gas is gas that leaves the state and is used outside the state, with the exception of Cook Inlet gas. Co-Chair Hawker clarified that the gas referred to would be from the North Slope. Mr. Marks agreed that the liquid natural gas (LNG) is part of Bucket 1; export gas would come from outside of Cook Inlet and leave the state, such as North Slope gas that would go to Canada and the Lower 48. Representative Gara pointed out that there could not be a separate, lower tax on gas used in-state. He asked whether the Bucket 2 language could stipulate that decoupling would begin when North Slope gas began to be exported. He was concerned with constitutional issues. Mr. Marks responded that Bucket 2 would be empty until a major gas sale is made and that the in-state gas would be Bucket 1. 3:24:16 PM Mr. Marks pointed to Slides 10 and 11 with visual illustrations of the two buckets. Representative Fairclough asked whether Bucket 1 would have the combined tax rate and Bucket 2 would not. Mr. Marks answered in the affirmative; the combined tax rate currently in effect would be in Bucket 1. Co-Chair Hawker added that pure decoupling, or putting all gas in one bucket and all oil in another, would penalize the companies that are currently producing both oil and gas. Mr. Marks reported that the bucket system was structured in the Senate Finance Committee; the intent was that there not be a tax increase at this time. Vice-Chair Thomas queried the tax rate for spur lines taken off the main gasline. He wondered what the royalty rate would be to the in-state users. Mr. Marks responded that under the current production tax, all in-state gas has a tax rate that is subject to old ELF provisions, a low tax of $0.17/MMBTU regardless of the price. Vice-Chair Thomas clarified that the rate applied to any gas used in the state. Co-Chair Hawker acknowledged that current statute could face federal constitutional challenges, as different tax structures are set up for in-state gas from the same source. He stated that the possibility would not become real until the state has actually exported gas. He thought the issue did not have to be dealt with in the current legislative session. 3:28:28 PM Representative Gara wanted the bill written in a way that is constitutional. He fully intended to leave the lower tax rate on in-state use of gas as long as possible. Representative Gara summarized that by mixing oil and gas, the state essentially short-changes itself on the oil tax rate in cases where there is low-priced gas. Mr. Marks agreed. Representative Gara stated for the record that the state is currently giving a benefit to companies like ConocoPhillips by allowing them to dilute oil tax payments with Cook Inlet gas costs. Mr. Marks agreed. Co-Chair Hawker took issue with the language "short- changing" the state, which implied a motive that he did not think existed. Representative Gara restated that one of the benefits to producers who provide in-state gas is a slightly lower tax rate. Mr. Marks responded that PPT was designed as a state- wide tax based on state-wide activity. Combining oil and gas does reduce the tax. Co-Chair Hawker explained that the sponsor's bill did not intend to fiscally impact current producers relying on current law. The bill intended to accommodate the interim period and not disrupt producers from developing new gas sources. He noted that the House Resources Committee addressed the issue by creating a window that would open and then close through a trigger mechanism. He referred to concerns about the mechanism and hoped to find a better one allowing a durable statute that would provide the hold- harmless for existing producers. He reported that his office had been working closely with the consultants and DOR; both had arrived at a similar concept on a joint proposal that would address the issue. 3:33:58 PM Representative Kelly asked whether the major players from the industry would be present for the discussion. Co-Chair Hawker anticipated that they could join in public testimony voluntarily or they could be required to join. Representative Kelly wanted a complete record and hoped they would be required to participate. Representative Austerman asked for clarification regarding LNG. Mr. Marks explained that the portion of the gas that stayed in-state would be Bucket 1; North Slope gas that was exported through an in-state line through Southcentral and Valdez would be Bucket 2. Co-Chair Stoltze stated that he did not want producers to be compelled to testify. 3:37:17 PM Representative Kelly maintained that it would be a mistake to leave out information from the group because of the short time allowed. Representative Fairclough agreed with comments on both sides of the issue and suggested that a time could be specified for testimony from the players. Co-Chair Hawker spoke to the timeline for the amendment. SB 305 was HEARD and HELD in Committee for further consideration. 3:40:22 PM AT EASE 4:03:00 PM RECONVENED