CS FOR SENATE BILL NO. 21(FIN) am(efd fld) "An Act relating to the interest rate applicable to certain amounts due for fees, taxes, and payments made and property delivered to the Department of Revenue; providing a tax credit against the corporation income tax for qualified oil and gas service industry expenditures; relating to the oil and gas production tax rate; relating to gas used in the state; relating to monthly installment payments of the oil and gas production tax; relating to oil and gas production tax credits for certain losses and expenditures; relating to oil and gas production tax credit certificates; relating to nontransferable tax credits based on production; relating to the oil and gas tax credit fund; relating to annual statements by producers and explorers; establishing the Oil and Gas Competitiveness Review Board; and making conforming amendments." 1:34:26 PM Co-Chair Stoltze discussed the meeting agenda. MICHAEL PAWLOWSKI, ADVISOR, PETROLEUM FISCAL SYSTEMS, DEPARTMENT OF REVENUE, presented the PowerPoint presentation: "Fiscal Impact HCS CSSB 21(RES)." He noted that the analysis focused on a long-term policy goal to increase oil production in Alaska in the near-term and into the future. DAN STICKEL, ASSISTANT CHIEF ECONOMIST, DEPARTMENT OF REVENUE, communicated that the department had identified 15 areas included in its fiscal analysis. The department would provide information about each of the areas and would conclude with a summary table showing the total fiscal impact of the bill over the upcoming 6 years compared to the fall 2012 forecast. He added that the fiscal note did not consider potential additional production that could be incentivized by the legislation. The presentation would also look at revenue sensitivity under Alaska's Clear and Equitable Share (ACES) and various versions of SB 21 specifically for FY 15. Mr. Stickel pointed to slide 3: "1. Repeals Progressive Surcharge." Under the current ACES system the surcharge was the additional tax that applied when the production tax value was in excess of $30 per barrel. The fiscal impact of the repeal ranged up to $1.8 billion per year. 1:40:26 PM Co-Chair Stoltze asked what the price of oil had been when ACES was implemented. Mr. Stickel believed the price had been in the $60 range. Representative Gara asked Mr. Stickel to repeat his comments about the impact of the elimination of progressivity. Mr. Stickel replied that the repeal of progressivity would have an impact of up to $1.8 billion per year. Mr. Stickel moved to slide 4: "Impact of Progressive Surcharge." The slide showed revenues from the ACES 25 percent base tax and on the progressive tax portion from FY 08 to FY 19. He pointed out that going forward the progressivity revenue was in the $1.8 billion to $1.5 billion range between FY 13 and FY 19. He noted that under the current rates the department forecasted larger revenues from the base tax than from the progressive tax. Mr. Stickel turned slide 5: "Increases Base Production Tax Rate." He explained that under the legislation the base rate would increase from 25 percent to 33 percent (a decrease from 35 percent was included in the prior bill version CSSB 21). He elaborated that the change would bring a revenue increase to the state of up to $875 million per year. He noted that the difference between the 33 percent and 35 percent base rates would be between $200 million to $250 million annually. 1:42:21 PM Vice-Chair Neuman wondered how the elimination of progressivity would mean that oil and gas would be taxed separately. He had been told that removing a BTU equivalency section of the current law and eliminating progressivity would have a decoupling effect. He stated that progressivity was a multiplication function on the tax and the BTU equivalency functioned to ensure that a tax rate was followed for the producer's average monthly production tax. Mr. Stickel responded that under the ACES system the progressivity surcharge factored in oil and gas and was brought down by the lower gas value. He expounded that when a producer had different commodity values there were varying impacts on the surcharge. He explained that by eliminating progressivity and taxing at a flat rate, gas production would no longer change the tax rate. Under HCS CSSB 21(RES) the base production tax would be 33 percent for gas and 33 percent for oil. 1:44:56 PM Vice-Chair Neuman stated that under ACES there was a standard allowable deduction on capital and operating expenses at the wellhead value. He clarified that the flat rate under the legislation would include the same components. Mr. Stickel agreed and stated that the underlying calculation of the production tax value was not changed in the legislation. Co-Chair Austerman asked the department to review the material as clearly and simply as possible for the benefit of the committee and the public. He pointed to the information on slide 3 stating that the fiscal impact would be up to $1.8 billion. He asked what the fiscal impact pertained to. Co-Chair Stoltze requested simplicity and asked for other department staff to augment with detail on slides as well. 1:47:29 PM Mr. Pawlowski explained that the progressivity surcharge was a tax that was added to the 25 percent base tax rate; its elimination would have a revenue impact on the state. The department endeavored to look at each revenue piece separately given that some provisions had fiscal impact to the state whereas others did not. He referenced slide 4 and stated that while progressivity was a large piece of revenue generated under ACES, the base tax rate also generated significant revenue. For example, under the FY 14 forecast the base tax rate was estimated to generate $2.775 billion and progressivity was estimated at $1.55 billion. He clarified that the slide showed the impact of revenue raised prior to the application of credits. Representative Wilson asked whether $1.8 billion would be subtracted [potential loss related to the elimination of progressivity] and $875 million would be added as a result of the base tax rate increase from 25 percent up to 33 percent (slide 5). Mr. Pawlowski answered in the affirmative. Mr. Stickel expounded that the presentation included a summary table showing the collective fiscal impact of the provisions. 1:50:31 PM Representative Gara looked at high revenues earned under ACES in FY 08 and FY 12 (slide 4). He wondered if FY 12 was the year that oil reached $140 per barrel and if retroactive taxes had caused the high number in FY 08. Mr. Stickel replied that oil prices had reached $140 per barrel in FY 08. He detailed that the state had taken in close to $1 billion in a specific month in FY 08. Co-Chair Stoltze believed the retroactive provision had expired after two or three years. Representative Gara asked if the high revenue in FY 12 was a result of high oil prices as well. Mr. Stickel replied in the affirmative; prices had consistently been above $100 per barrel throughout FY 12. Co-Chair Austerman pointed to slide 5 and asked for verification that the state's revenue would increase up to $875 million annually [due to an increase in the production tax rate]. Mr. Stickel responded that the $875 million revenue growth referred to an increase in the base production tax (based on the fall 2012 forecast), which would vary by year. He elaborated that the $875 million reflected a change in the FY 16 forecast due to an increase in the base tax from 25 percent up to 33 percent. 1:52:55 PM Mr. Pawlowski moved forward to slide 21: "Provisions in HCS CSSB 21(RES) and Their Estimated Fiscal Impact as Compared to Fall 2012 Forecast ($millions)." He noted that the slide showed revenue impacts without a change in production. Provisions in HCS CSSB 21(RES) were numbered on the left of the slide. He believed it was pertinent to focus on FY 15 as it would be the first full fiscal year impacted by the legislation. Co-Chair Austerman noted that slide 21 showed a reduction in $875 million; whereas slide 5 showed an increase in $875 million. He assumed the numbers were not the same. Mr. Pawlowski replied that the number on slide 5 was related to the upper maximum in the table on slide 21. He elaborated that the elimination of progressivity would mean a maximum loss in revenue per year of $1.8 billion (shown in the FY 17 forecast); the revenue increase of $875 million was shown on line 2 in FY 16 (slide 21). Co-Chair Austerman asked for clarification on the $1.8 billion impact shown on slide 3. He wondered if the impact was a gain or loss in revenue to the state. He reiterated his earlier comment about providing clarity for the public. 1:55:28 PM Mr. Pawlowski answered that the overall fiscal impact would be best described by the FY 15 analysis (tax was determined in a calendar year). He pointed to slide 21, line 1 showing that the elimination of progressivity would result in a loss of $1.5 billion in FY 15 based on the fall 2012 forecast. Line 2 showed that an increase in the base tax rate to 33 percent would increase income by $850 million in FY 15. Line 3 included an increase of $700 million in revenue as a result of the limitation on credits for qualified capital expenditures for the North Slope (20 percent spending credit). He noted that line 3 only pertained to taxpayers who directly took credits to offset their production tax liability. Line 4 showed a minimal revenue impact for the net operating loss (NOL) credit increase from 25 percent to 33 percent. He detailed that the NOL credit was available to small explorers who were spending more than they were earning through production; the change would impact the operating budget where credits would go through the credit fund. Mr. Pawlowski moved to line 5 that showed a $25 million decrease in FY 15 revenue related to the gross revenue exclusion for oil production in new units and new or expanded participating areas. The provision eliminating the requirement for credits to be taken over two years would only have a fiscal impact in FY 14, which was projected at an increased $250 million (reflecting credits that would have normally been taken in FY 15). He explained that the fiscal impact was limited to FY 14 because the obligations created by companies spending in calendar year 2013 were an obligation to the state. He furthered that when a company made a qualified capital expenditure it earned a credit based on 20 percent of the expenditure; under current law the company had to divide the credit over a two-year period. He expounded that the intent of the legislation was to close out the fiscal obligation to the state. Mr. Pawlowski continued on slide 21, line 7 showing no fiscal impact of an amendment to the community revenue sharing fund. He detailed that the item was linked to the corporate income tax receipts under the legislation, but it did not change the functioning of the program or the legislature's authority to appropriate. Line 8 pertained to a $5 per taxable barrel sliding scale credit, which was based on the price of oil. The change would result in a reduction in state revenue of up to $825 million in FY 15 based on the forecast production. He noted that if production was higher the credit rate would increase. Line 9 showed the qualified oil and gas industry expenditure credit, which was a corporate income tax credit for manufacturing or modification of tangible personal property (e.g. modules, truck and pipe improvements, and other). The impact of the credit was indeterminate, but had an upper range of $25 million per year in decreased revenue. He detailed that the credit was limited to a company that paid tax and could only be used to reduce the company's individual tax liability. Mr. Pawlowski addressed slide 21, line 10 pertaining to the reduced interest rate for late payments and assessments on most taxes; it showed an indeterminate fiscal impact with a possible $25 million loss in revenue per year. Line 11 showed zero fiscal impact resulting from the removal of the 3-mile requirement for the Frontier Basin tax credit (the change had been made in the House Resources Committee). He communicated that the change showed no fiscal impact because the Middle Earth [Interior Alaska] exploration credit was included in the department's current production forecast. Line 12 addressed the extension of the fixed $12 million small producer credit to 2022; the credit applied to companies producing less than 100,000 barrels BTU equivalent per day. He noted that there was no fiscal impact in the near-term; in FY 17 through FY 19 there was a loss in revenue projected as a result of new production from new qualifying entities. Line 13 referred to the 2016 required report to the legislature from the department. He remarked that the report requirement was in lieu of the competitive review board. The report requirement cost would be absorbed by the department and would generate zero additional cost to the state. Mr. Pawlowski moved to line 14 related to a requirement to consider joint interest billings in the audit process. The fiscal impact of the requirement was indeterminate; it was challenging for the department to determine how the requirement worked through the current audit process. Line 15 showed zero fiscal impact for Alaska Industrial Development and Export Authority (AIDEA) bonding authority to finance oil and gas processing facilities. He communicated that the total revenue impact to the state including all 15 items was projected at a loss of $800 million to $850 million per year. 2:04:06 PM Representative Costello referred to prior testimony that a tremendous amount of revenue was brought in through the progressivity feature under ACES and that a significant portion of the revenue was distributed in capital credits. She had been told the number was approximately $850 million. She wondered where the amount was reflected on slide 21 and noted the numbers seemed lower on the slide. Mr. Pawlowski replied that there were two tiers in relation to companies eligible for the qualified capital expenditure credit. One tier included companies with a tax liability that used the credit to reduce their liability. The other tier included companies without a tax liability that were issued a credit; the credit came through the state's operating budget via the oil and gas credit fund. The impact on the operating budget was $150 million in FY 15; whereas the combination of the two tiers equaled the $850 million. 2:05:37 PM Representative Gara stated that the base tax rate of 33 percent was misleading. He pointed to lines 2 and 8 and surmised that a 33 percent tax rate would generate $450 million more than a 25 percent tax rate, but with the $5 sliding deduction $425 million out of the $450 million was lost. Mr. Pawlowski pointed out that the state would also gain $300 million from the capital credit elimination. He noted the numbers pertained to FY 14 (slide 21). He detailed that when comparing the progressivity between the two, the number would be a negative $525 million. Representative Gara asked if the department could provide different variations of the data on slide 21 assuming various oil prices. Mr. Pawlowski directed attention to a chart on slide 30: "Production Tax Revenue, Less North Slope Refunded and Carried-Forward Credits." The data pertained to FY 15 only, given that it would be the first full year the legislation would impact. The impact was shown across a range of prices ($50 to $150) and for various versions of the legislation (from left to right: ACES was shown in blue, SB 21 was shown in red, CSSB 21(FIN) was shown in yellow, and HCS CSSB 21(RES) was shown in purple). Representative Gara spoke to a ConocoPhillips projected production decline of 3 percent for legacy fields beginning in FY 17. He stated that the DOR forecast used a steeper rate of decline and requested data using a 3 percent decline from FY 17 going forward. Mr. Pawlowski was happy to work with the committee on forecasted decline. He noted that Conoco's 3 percent decline rate was limited to legacy fields under its operation (the Colville River and Kuparuk River units). Representative Gara responded that an article using the 3 percent decline beginning in FY 17 included all of the legacy fields operated by Conoco, BP, and Exxon. He noted that Conoco estimated that its decline rate would be less than 3 percent beginning in FY 17 given its other oil fields. Co-Chair Stoltze relayed that ConocoPhillips would have a chance to present to the committee in the future. 2:10:35 PM Co-Chair Austerman looked at slide 21, line 2, which showed the 33 percent base tax. He pointed to FY 15 and asked if the $850 million was representative of the 33 percent tax and what the number would be under the current 25 percent rate. Mr. Pawlowski replied that the $850 million was the difference between a 25 percent and 33 percent base tax rates. Representative Munoz followed up on a question by Representative Costello related to how companies received the capital expenditure credit. She wondered why the entire amount was not reflected on slide 21. Mr. Pawlowski replied that only looking at revenues brought in by tax payers would have ignored the obligation created by credits paid through the operating budget; therefore the items had been broken out to clarify the expenditure by the state. The total revenue impact (only factoring in revenue) would be underestimating the bill's fiscal impact by $150 million. He remarked that it was difficult to represent the two items in the fiscal note. 2:13:01 PM Representative Munoz asked for verification that there was an additional $400 million or $450 million not reflected in bill's bottom line impact to the state. Mr. Pawlowski replied that the total revenue impact was shown below line 15 on slide 21. The impact on the operating budget was shown below and included in the bottom line total fiscal impact on slide 21. Representative Gara pointed to slide 21, line 8 and observed that the tax rate would not reach 33 percent until oil reached a price of $150 to $160 per barrel. Mr. Pawlowski agreed that the impact on line 8 did reflect an offset against the increase. Vice-Chair Neuman asked what the cost of the gross revenue exclusion (GRE) would be to the state. He wondered what the cost to the state would be under the current standard allowable deduction system. Mr. Pawlowski replied that the GRE impact was represented on slide 21, line 5. The estimated impact in FY 15 was approximately $25 million. He noted that qualifying production had been strictly limited to new oil that had not been forecasted at present. Representative Costello observed that the fiscal impact of the GRE was projected at $50 million, but that it was also listed as indeterminate. She wondered how the department had approached the estimate and the unknown factors involved. She assumed the worst case scenario had been used in the assumption. 2:16:58 PM Mr. Stickel replied that the GRE took the forecasted production from the barrels and fields that would qualify for the new unit and expanded participating areas. He believed the number was 2 percent to 3 percent of the total production for FY 15. The department also looked at the forecasted production tax revenue with and without the GRE applied to the barrels for the qualifying fields, which was how the $25 million cost had been determined for FY 15. He believed $25 million for the HCS CSSB 21(RES) version of the bill was a good estimate; there was little uncertainty about which barrels would qualify. He noted that the prior version had included a more liberal definition about what qualified as new oil. The uncertainty had been higher under the prior version and the department had provided a range of revenue estimate. 2:18:45 PM Representative Edgmon pointed to slide 21, line 7 and surmised that it was unlikely the community revenue sharing fund would exceed $60 million given its tie to corporate income tax unless a large uptick in activity occurred. Mr. Stickel replied that the total corporate income tax collections from oil, gas, and other corporations had been over $500 million in each of the past eight years and collections were continued to be forecasted at over $500 million per year for the length of the fiscal note. He added that the $60 million threshold would easily be reached. Representative Edgmon questioned whether there would be a decrease to the current $60 million. He believed an additional $20 million to $25 million added to the revenue sharing program in the last couple of years. He was interested in the impact of tying revenue sharing to the corporate income tax provision of the bill. Mr. Pawlowski believed it was illustrative to look at the progressivity piece (slide 4) because that was where community revenue sharing dollars were softly dedicated to the revenue sharing fund. He discussed language that was up to 20 percent of the progressive portion or $60 million to $180 million. He furthered that given the $500 million annual corporate income tax revenue the department was comfortable that plenty of revenue would be available for the revenue sharing program. He stressed that the legislation did not attempt to change how much would be appropriated to the fund. The intent was to locate a revenue stream that would meet the $60 million to $180 million to meet the obligation under the statute. 2:21:38 PM Representative Edgmon relayed that an interactive presentation demonstrating how changing numbers around would impact the data. He wanted to be prepared for unexpected events such as decreases or increases in various areas. He referred to the importance of stress testing. Co-Chair Austerman referred to his earlier question related to $850 million. He clarified that the spring revenue forecast was based on the ACES 25 percent production tax. Mr. Stickel replied in the affirmative. He detailed that the spring forecast was based entirely on the current ACES production tax. He noted that slide 21 was based on the fall forecast. Co-Chair Stoltze made a remark about tying government growth to production. Mr. Pawlowski relayed that slide 21 was included on page 4 of a department fiscal note [FN10 (DOR), 4/8/13]. The department felt the slide integrated the bill's provisions without factoring in any changes to production or price. He referred to a presentation by Econ One from the previous day and to the importance of long-term decisions beyond the timeline shown on the fiscal note. Co-Chair Austerman asked whether the fiscal note reflected the fall 2012 or spring 2013 revenue forecast. Mr. Pawlowski replied that the note reflected fall data; the department was currently working to update it for the spring forecast. 2:24:35 PM Representative Edgmon referred to a news article discussing that the reduction of oil taxes should be thought of as an investment to increase production. He wondered if a projection of the potential increase in production resulting from the legislation would be provided to the committee. Mr. Pawlowski pointed to slide 22: "Production Scenarios." He cautioned that any methodology looking at increased production had flaws. The department had attempted to provide a scenario method that examined different production increase profiles. Scenario A: · New 50 Million barrel field developed by small producer without tax liability · Peak production = 10 thousand bbls/day · Development costs = $500,000,000 · Qualified for GRE and NOL Mr. Pawlowski relayed that ACES and the legislation used a net tax. He expounded that it was important to also consider the cost of reaching the production, which would have a fiscal impact. Scenario A represented the addition of one new 50 million barrel field. 2:27:25 PM Mr. Pawlowski discussed Scenario B on slide 23: "Production Scenarios." He communicated that the scenario provided the most reasonable expectation for the near-term. He emphasized that the scenarios were not meant to be predictive. Scenario B: · Operators of existing units add 4 drill rigs to current plans · Each rig adds 4,000 bbls/day in new production each year o Which each then decline at 15% per year · Does not qualify for GRE Mr. Pawlowski elaborated that it was important to factor in a decline rate when looking at oil production. He looked at Scenario C on slide 24: "Production Scenarios." Scenario C: · Operator of existing legacy unit builds new drill pad · Development cost = $5 billion · Adds 15,000 bbls/day in 2014 increasing to peak rate of 90,000 bbls/day in 2018 · Does not qualify for GRE Representative Holmes wondered about development costs associated with Scenario B. Mr. Pawlowski pointed to page 5 of the fiscal note [FN10 (DOR), 4/8/13] and relayed that the development cost for each well was estimated at $20 million. The figure was on the high side of current cost on the North Slope, but he believed it was indicative of future development costs. Representative Gara expressed a concern related to Scenario A (slide 22). He agreed that incentivizing new field production was necessary. He asked for verification that the GRE or the reduction in tax for a new field was 20 percent. Mr. Pawlowski replied in the affirmative. Representative Gara asked whether the 20 percent GRE would reduce the base tax rate by more than 20 percent. Mr. Stickel replied that the 20 percent GRE was based on the gross oil value and was subtracted from the net value. He agreed that the impact of subtracting 20 percent of gross would be a reduction of greater than 20 percent of net. He explained that the exact percentage would depend on the price of oil. Representative Gara addressed tax rates of future new fields. He stated that at $110 per barrel oil companies would not pay a 33 percent tax due to the $5 sliding scale [slide 21, provision 8]. He asked for a rough tax rate estimate for FY 15 before the GRE. Mr. Pawlowski asked for clarification on which presentation Representative Gara was referencing. 2:32:55 PM Representative Gara pointed to slide 21 of the DOR presentation. He noted that line 2 assumed a 33 percent tax rate, but the $5 per taxable barrel credit meant that companies would pay less than 33 percent. He stated that based on the chart the $5 credit would mean a reduction of $825 million from the $850 million in gained revenue resulting from the base tax rate increase to 33 percent. He assumed that the actual tax rate on companies was closer to 26 percent or 27 percent with the inclusion of the $5 per barrel credit. He wondered if the assumption was fair. Mr. Stickel replied that at the forecast price the base tax increase from 25 percent to 33 percent was roughly offset by the per taxable barrel credit. He stated that the effective tax rate factoring in only the two provisions would be approximately 25 percent. He offered that the department could provide more specific calculations that encompassed all of the components. Representative Gara pointed to the GRE, which subtracted roughly 35 percent from the 25 percent tax rate. He surmised that the tax rate would be approximately 17 percent when factoring in the GRE. Mr. Stickel answered that the amount was roughly in the ball park. Representative Gara understood that companies needed to make up for sunk costs in the development of new fields, but he wondered if the department had thought about a time limit for the GRE. He did not know what the state would be able to fund if it had to live off of a 17 percent tax rate. Mr. Pawlowski responded that a time limit on the GRE had been discussed in multiple committees; the department was concerned that it could create distorting effects on behavior. Specifically, how investment behavior would change if taxes were increased at the end or partway through the useful life of a well. The department was more comfortable with the more narrowly defined definition of new oil in the current bill. He elaborated that DOR did not see all of the new oil in the foreseeable future coming from GRE eligible barrels because it did not apply to the basic legacy production. He relayed that Mr. Stickel would speak to the forecast related to non-GRE eligible production. Representative Gara understood that the GRE did not apply to everything. He discussed areas that would qualify for the GRE including new geological units in legacy fields, Umiat, Nakiachuk, Oooguruk, CD5, and other oil. He stressed that the provision would apply to a significant amount of oil. He wondered if the state could fiscally sustain a 17 percent tax rate on the oil that would be included. Mr. Pawlowski replied that the department had looked at what the state could afford to offer in credits particularly when it would not receive equal royalty into the future. He believed CD5 was largely on non-state land; the state paid through the credits and the deduction in ACES. He furthered that the state invested, but did not have the other components to provide the revenue to pay back. The department was concerned about the state not receiving the full royalty from the production and paying for it upfront. The administration was more comfortable with inspiring increased production in a way that did not have the state as invested in the upfront development, particularly when there was not the full balance of the royalty to support the state. 2:38:40 PM Representative Gara believed that the ACES tax system would be eliminated in the near future. He asked about the pros and cons of a significant amount of new oil being taxed at a rate of approximately 17 percent and approximately 25 percent. He wondered why a 7-year to 10-year time limit on the lower tax should not be imposed. Mr. Pawlowski answered that when incentives changed behavior also changed. He stated that the concern was related to how tax increases would impact declining production; costs would rise and increased taxes may cause incentive to shut in the production. The fear was that the change would discourage production in the future. Representative Kawasaki asked if the production scenarios provided were likely and how they were developed (slides 22 through 24). Mr. Pawlowski replied that the scenarios had initially been developed based on how something works without trying to be predictive. He stated that predicting the magnitude of the change was very difficult. He furthered that each scenario was a realistic concept, but they were intended to be illustrative. He pointed to Scenario B and relayed that [operators of existing units] adding 4 new drill rigs was not necessarily realistic. The department wanted to avoid doing a direct correlation between increases in spending and a direct percentage increase in production. He remarked that it cost money to develop oil, production happened, and then production declined; the items needed to be built into a model given a net system in order to provide a realistic picture for policy makers. Representative Kawasaki believed there would be more value to the scenarios if they were in a current development plan under the Division of Oil and Gas. 2:42:53 PM Mr. Pawlowski replied that the department had worked with its economic research group to go through current DOR data to get ideas on cost, development, and projects and had built the data into the models. He relayed that the models were not based on any individual opportunities. Representative Kawasaki wanted to ensure that the public understood that the scenarios were illustrative in nature. Mr. Pawlowski stressed that DOR had attempted to move away from anything that was not indicative of what actual developments and projects would look like. The intent was to produce something reasonable to show the public related to the types of production. Representative Holmes referred to the CD5 oil field. She pointed to the department's concern that under ACES the state may not collect royalties on developments off of state land; therefore, production tax would make up the entire revenue for the state on those areas. She furthered that in the existing system there was interplay of the state paying credits and the way the tax ran; she noted the state could end up under water. She asked how the situation would look under the proposed legislation and whether the state would be on safer ground. Mr. Pawlowski replied that the removal of the buy-down effect had the largest impact. He elaborated that under the net system the state support for company spending was at the 25 percent rate plus the buy-down effect. He remarked that PFC Energy and Econ One had talked about state support for a project in the 80 percent range. The spending was different under the current system because it was limited to the basic tax rate (33 percent in the current bill); for an existing company developing a field, the state supported at 33 percent. The state would take a production tax equivalent to the tax rate minus the GRE effect and the per barrel future credit. He furthered that the scenario was different than the buy-down effect and the capital credits that came out up front in the current tax system. He stated that there would be less potential for the state to go negative in the situation than there was under ACES. He referred to the decoupling effect and a previous PFC Energy presentation. He detailed that the impact to the state could be negative if a high value resource such as conventional oil was combined with a low value resource like viscous or high cost oil; the proposed system would not create the same effect, but it was primarily linked to the buy-down effect and not the credit structure. Under the current system moving into the field, a company would have the ability to write off expenditures against its taxes and to receive 33 percent support. The company would receive a per barrel production credit and the GRE for new fields. The department saw the royalty being dramatically different in comparison to the current system. 2:48:25 PM Representative Wilson asked if the state could continue to fund its budget with oil as the main resource. She observed that oil is not a renewable resource and believed a change needed to be made to stretch its production lifespan out in Alaska. Mr. Pawlowski focused on the power of production. He referred to various presentations by departments showing that Alaska was resource rich; approximately 3.5 billion barrels of oil remained in the legacy fields and an additional 3 billion barrels were waiting to be discovered. He explained that roughly 10 percent of the resource needed to be developed to continue to drive the revenues seen under ACES with forecasted declines. He stated that in the long-term the issue was about production being able to sustain vital revenues to the state. He noted the importance of discussing the relationship of state revenues and the value being created. He pointed out that the state received revenues in multiple ways in addition to the production tax. The scenarios provided in the presentation looked at production compared to the current system. He suggested looking at the scenarios as underestimates. He wanted to focus on what the production could do to drive the long-term sustainability of Alaska as opposed to looking at other revenue sources. Representative Wilson understood that Alberta had recently changed its tax structure. She wondered if the change had made a difference. Mr. Pawlowski replied that DOR would provide the committee with benchmarking data from prior presentations that showed a dramatic increase in investment and production in Alberta. He noted that Alberta was currently experiencing some significant challenges due to low oil prices caused by stranded production. Representative Wilson remarked that Alaska could look to other locations that had experienced similar issues to gain information about outcomes. 2:51:54 PM Representative Gara referred to the possibility that the Alberta tax cut had raised the value to equalize the offset. He relayed that the province was facing $2 billion to $3 billion budget deficits. He stated that when too much was spent on tax breaks it was possible to lose money. Mr. Pawlowski referred to a Wall Street Journal article from the past December that indicated there was oil at $50 per barrel if tankers were available to transport it. He stated that there was a significant amount of oil produced in Alberta with very little infrastructure to transport it. He discussed various pipeline proposals. He understood that the increased production was largely due to the decline in price. He agreed that Alberta was facing a fiscal deficit. Mr. Pawlowski continued to discuss Scenario C on slide 24: "Production Scenarios." The scenario included a large drill pad development with multiple wells, increased production, and billions of dollars in spending. He furthered that the scenario was an aggregate of the small field, the rigs, and the addition of the large pad. He moved to slide 25: "Production Profiles of Production Scenarios." The slide illustrated production numbers associated with Scenarios A through C. He pointed to FY 14 and noted that the blue bar to the left represented forecasted production; Scenario A did not add new oil, Scenario B increased production from 539 to 555 thousand BoPD, Scenario C increased production to 570 thousand BoPD. The chart provided data for FY 14 through FY 19 including decline curves with production layered on top. Representative Gara asked whether actual projects had been identified under Scenario C that would go online as a result of the bill. Mr. Pawlowski answered that the scenarios were hypothetical based on the department's understanding of the type of spending that would occur. The information was intended to be illustrative of realistic elements that could occur. 2:55:46 PM Mr. Pawlowski discussed slide 26: "Projected Revenues under Production Scenarios at $90/Barrel ANS." The slide showed rounded unrestricted general fund revenue at various prices for the different production scenarios. The goal was to present the sensitivity level of a new revenue system on production. The chart provided a time limited (FY 14 through FY 19) illustrative scenario based on production figures shown on slide 25. Mr. Pawlowski turned to slide 27: "Projected Revenues under Production Scenarios - at $100/Barrel ANS." The bar in black on the far right showed ACES at the forecast production (other scenarios were shown for comparison). He pointed to Scenario B in FY 16, which showed that $5 billion would be raised under the proposal and $5.2 billion would be raised under ACES. Representative Gara recalled testimony that it would take roughly seven years from the start to bring new production online. He wondered why the chart showed new production coming online within three and four years. Mr. Pawlowski replied that adding a new rig to the legacy fields could offer near-term opportunity and provide a quick turnaround in production. He reiterated that the slides were illustrative. He furthered that adding a new rig could be done quickly; therefore, it was not GRE eligible under the analysis. Representative Gara asked for verification that there were no commitments from any company that developments would occur as a result of the bill. Mr. Pawlowski responded that the oil industry was better equipped to answer the question. 2:58:43 PM Representative Costello observed that Scenario C preformed the best. She asked the department to carry the analysis beyond FY 19. She stated that the bill had a short-term cost with the hope of a long-term gain. Mr. Pawlowski replied that there were various requests that the department could work with committee members on in order to provide the desired information. Mr. Pawlowski moved to slide 29: "Projected Revenues under Production Scenarios - at Forecast ANS Price." The slide showed how sensitive the scenarios were to moderations of the decline curve to potentially create revenues that could offset the revenue reduction under ACES. Representative Edgmon discussed department comments that U.S. oil production was at historic high levels. He noted that production was increasing globally as well. He wondered if a lack of infrastructure would provide a limitation on the production scenarios. Mr. Pawlowski replied with a reference to work done by Econ One related to how much resource needed to be developed over the long-term. Econ One had looked at what would happen if Alaska trended along with its peer group following 2006; it had examined what spending would be like at present and how much resource there would be. Econ One had also looked at the relationship between government take and potential drilling and how many wells would need to be developed over what period of time. He stated that when considering the longer-term, it was necessary to look at the opportunity to exceed the break even. He furthered that the availability of capital as opposed to infrastructure was the bigger question; whether companies had the capital to reallocate quickly to develop resources in Alaska. He encouraged members to ask the industry questions about its ability to reallocate capital. He expounded that the change would not happen immediately, but the attractiveness of the tax system would make companies decide to reallocate capital to Alaska to be competitive. 3:04:17 PM Representative Holmes discussed slide 21 and the difference between an impact on revenue and on the operating budget. She pointed to slides 26 through 29 that showed projected revenues under various scenarios. She asked whether the slides also considered the impact of credits paid out under the existing system on the state's operating budget. Mr. Pawlowski believed the revenue projections factored in the credits that would be paid out. Representative Gara queried what 5.5 stood for in FY 19 (slide 29). Mr. Pawlowski answered that the figure was $5.5 billion in GFUR [General Fund Unrestricted Revenue]; the bars represented revenue forecasts under the various scenarios. Representative Gara referred to testimony by the major oil companies that technology was preventing the production of massive amounts of heavy oil in Alaska. He recalled a BP testifier who had said that the issue was technological and not fiscal. He stated that Conoco had said it planned to increase production, which would decrease its rate of decline to approximately 3 percent. He was concerned that the department was applying a 17 percent tax rate to new oil, which was likely to be produced under the current ACES system anyway. He was worried the state would unnecessarily incentivize some items. 3:07:16 PM Mr. Pawlowski replied that it was related to what the state assumed would happen. He agreed that Conoco had made comments about its specific production and decline rate. He addressed the question about new oil and what would happen and looked at projects that were on the horizon, but did not happen (e.g. Liberty). He surmised that the root question was about relying on the revenue forecast to determine what would actually happen in the future and using that to define new versus old oil. The department was concerned that much of what was projected to occur under ACES would not occur. He pointed to testimony from Ken Thompson (of Brooks Range Petroleum) that the company had been to over 200 potential investors to pitch its 40 million barrel project under the current system; it had been unsuccessful and had asked the state to finance the project. BRUCE TANGEMAN, DEPUTY COMMISSIONER, TAX DIVISION, DEPARTMENT OF REVENUE, relayed that the department had incorporated information it learned from producers about expected decline rates into its fall revenue forecast (2012 Fall Revenue Forecast, page 43). Co-Chair Stoltze referred to a phrase "we're not fine with decline." Mr. Pawlowski agreed. He could provide committee members with a transcript of the Conoco analyst presentation. He added that the company had included that it saw an opportunity to reverse the decline if tax reform occurred. He pointed to the opportunity of production to provide a long-term sustainable base for the state. 3:10:29 PM Vice-Chair Neuman referred to slide 29 and the committee's discussion the prior day on well amortization running at about five years. He wondered whether the value resulting from the potential addition of four wells per year was included in FY 19. Mr. Pawlowski replied in the affirmative. The rig drilling under Scenario B would cost $20 million per year; the money would be spent up front and the production would come on and decline within the model. He added that 1,000 barrels per day had been used based on the current average productivity of a well in the Prudhoe Bay unit. Mr. Pawlowski pointed to slide 30: "Production Tax Revenue, Less North Slope Refunded and Carried-Forward Credits." The slide showed the fiscal impact of ACES and various versions of the legislation on production revenue for FY 15. Mr. Stickel explained that slide 30 illustrated the total impact of ACES and various versions of the legislation on production revenue for FY 15 including credits paid out. The amount of expected credit refund payments for the North Slope under each of the tax systems had been subtracted from the total production tax number. There were carry- forward credits at $50 per barrel in excess of the tax liability for major producers. He noted that the slide only looked at major provisions of the bill; an assumption for the corporate income tax and the reduced interest rate for late payments or assessments had not been included, which represented an impact ranging from $0.00 to $50 million. 3:13:46 PM Representative Gara asked which fiscal year slide 30 pertained to. Mr. Stickel responded that the chart pertained to FY 15. Mr. Pawlowski moved to slide 31: "General Fund Unrestricted Revenue, Less North Slope Refunded and Carried-Forward Credits." The slide related to FY 15 and attempted to incorporate other sources of state revenue outside of the production tax including royalty, property tax, and corporate income tax; it included the impact on revenue at oil prices ranging from $50 to $150 per barrel. 3:15:16 PM Representative Gara hoped to see the state to receive a more substantial share of the revenue when oil prices were high and oil companies were making record profits. He did not believe the state would have sufficient revenues to fund schools and other projects over the next 10 years. He wondered about an option that would allow the state share in the benefits when oil prices were high. He asked if DOR had modeled a scenario that would provide the state with a more substantial share as oil prices increased. He suggested an increase in revenue to the state when companies made $50-plus per barrel profit. He referred to a proposal the prior year to include a stair-stepped progressivity feature and wondered if the administration had considered it as a possibility. Mr. Pawlowski replied that under the legislation the effective tax rate and government take increased as prices rose. He stated that whether the bill increased the government take to levels preferred by committee members was a policy call the administration was willing to work on with the legislature. He furthered that the state's share increased with higher prices without the problems associated with the progressivity mechanism. Mr. Tangeman stated that if the current decline path continued the state would be limited in its ability to fund basic services 5 to 10 years in the future. He pointed to page 43 of the 2012 Fall Revenue Source Book, which projected production of 250,000 barrels per day in 2022. He stressed that it was critical to show an upside and potential in the state in order to layer on new oil to the legacy fields. The department believed it was critical to turn the decline rate around in order to fund basic services in 10 years. 3:20:06 PM Representative Gara communicated that every committee member wished to reverse the decline rate; he noted that there were varying views on how to meet the goal. He understood the department wanted to move away from the current progressivity mechanism. He stated that the bill would reduce tax rates down between 17 percent and 25 percent and would cap out at 33 percent even if prices reached $200 per barrel. He wondered if there were proposals that would allow the state to share in the profits in a way that would not damage oil production. He believed a 17 percent tax on new oil was low. Mr. Pawlowski believed the administration had been open to all input from each committee throughout the process. He agreed that government take was an important concept; at what point production and economics would not be hurt was taken into account. He stated that the administration was willing to work with the committee and its members. Representative Gara replied that he would schedule a meeting with the department. Representative Costello commented that she received emails from constituents who did not want changes made to ACES. She believed there was a compelling reason and need to explain what would happen if nothing was done [to decrease the current decline rate]. She appreciated the department's offer to work with committee members on the bill. Co-Chair Austerman pointed to slide 21. He discussed that a prior version of the bill passed by the Senate had included a 35 percent tax rate. He wondered if the department's model could insert the 35 percent tax to show what it would look like. He requested a breakout between the flat $5 per barrel and the sliding scale based on the department's projections related to volume and dollar value. Mr. Pawlowski agreed. He noted that Mr. Stickel could provide a verbal answer related to the difference between the 33 percent and 35 percent tax rates. Co-Chair Austerman requested the information in writing for all committee members. 3:24:21 PM Representative Gara pointed to a provision added in the prior committee [House Resources Committee] that would mean the state would rely on company and joint billing statements in auditing companies. He recalled that in the past most Democrats had wanted a gross tax because it was relatively straight forward. He pointed to concern that under the profits tax some companies could overstate their costs, understate revenue, or qualify something for a tax credit that should not qualify. He wanted DOR to have the most power possible to ensure that the state was receiving its intended return under the legislation. He wondered whether the department was more comfortable with the current auditing system than it was with the proposed auditing provision. Mr. Tangeman replied that the department had access to and used the joint interest billings; many other "tools" were also available to the department. He furthered that from an audit perspective it was necessary to rely on all available tools in order to get a job done. Representative Gara asked whether Mr. Tangeman would prefer the current auditing system or the one included under the legislation that was limiting. Mr. Tangeman answered that the provision had not been in the governor's original bill and had been added by the previous committee. 3:27:49 PM Vice-Chair Neuman looked at a provision related to lease expenditures and a change on pages 26 through 28. He discussed past concern related to "gold plating" and items allowable under lease expenditures. He observed that there were considerable changes in the legislation and asked for an analysis from the department. Mr. Tangeman replied that joint interest billings could be very lengthy and were shared between two companies. He expounded that the department did have access to the billings, but they were not used by all companies. He asked for clarification on the request. Vice-Chair Neuman referred to a subsection (B)(3) in the legislation, which stated that costs must be direct costs for exploring, developing, and producing. He stated that each producer was different; current statute included direct cost per individual for standard allowable deductions for production value. He stated that a new section included an arms-length clause that made it possible to be owner of the pipeline. He wondered about the best way to get the actual cost to the state. He understood the department had become fairly comfortable with the current system; he wondered how all of the changes would impact the department. Mr. Tangeman answered that it was the state's responsibility to have a relationship with every tax payer; any insights provided through the documents helped the department do its job. He relayed that relying exclusively on a document between two companies limited the department's insight into the information needed. He stressed the importance of the one-to-one relationship between the state and individual tax payers. 3:31:54 PM Vice-Chair Neuman surmised that Mr. Tangeman preferred the existing system. Mr. Tangeman answered that the department had developed the existing system over years and was comfortable where it was and where it was going under the net tax system. Co-Chair Stoltze remarked that the related thought process and conversation would be ongoing. Representative Edgmon looked at slide 21 and asked for a ballpark sketch on how a base tax increase from 33 percent to 35 percent would impact the data. Mr. Stickel replied that once the tax was put in place the difference would be in the $200 million to $250 million per year range. Representative Edgmon noted he had misunderstood earlier comments and had thought the difference in the base rate from 25 percent to 33 percent was $200 million to $250 million. Co-Chair Stoltze asked the department to clarify the information. Mr. Stickel answered that line 2 of slide 21 showed the increase in revenue to the state from the base tax. He detailed that moving from a base rate of 25 percent up to 33 percent would increase revenue in FY 15 by $850 million. He furthered that moving from a rate of 33 percent up to 35 percent would increase revenue by approximately $200 million to $250 million on top of the $850 million. The impact of moving from a base rate of 25 percent up to 33 percent would be slightly over $1 billion in increased revenue. Representative Munoz understood that a close relationship existed between changes to the base rate tax and the $5 to $8 per barrel credit. She asked for the per barrel credit impact to be included in the department's modeling of the change between a 33 percent and 35 percent base rate. SB 21 was HEARD and HELD in committee for further consideration. 3:35:41 PM RECESSED 4:08:05 PM RECONVENED