HOUSE BILL NO. 81 "An Act authorizing the commissioner of natural resources to modify a net profit share lease." 9:06:35 AM [Secretary Note: A prior meeting on HB 81 was held on April 22, 2021, at 9:00 A.M.] RYAN FITZPATRICK, COMMERCIAL ANALYST, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES (via teleconference), continued with the PowerPoint (copy on file): "HB 81 - Net Profit Share and Royalty Modifications on Oil and Gas Leases," beginning on slide 21. He discussed Slide 21 titled Eligible Scenarios for Modification: • Current statute for royalty modification; and • HB81 would allow net profit share modifications in these scenarios as well. A. New Production: If the development of a new field or pool would not be economic without modification, so long as the field or pool is sufficiently delineated. AS 38.05.180(j)(1)(A) B. Extend Production: To prolong the economic life of a field or pool when rising per-barrel costs (due to declining production or otherwise) would make continuing production no longer economic without modification. AS 38.05.180(j)(1)(B) C. Restore Production: To reestablish production of shut-in oil or gas that would otherwise not be economically feasible without modification. AS 38.05.180(j)(1)(C) • New scenario under HB81 proposal • Applies to net profit share modifications D. Incremental Production: If incremental production from producing pools requiring incremental capital expenditures is uneconomic in the absence of modification. Examples: Expansion of existing pools, additional drilling pads, enhanced oil recovery projects, etc. Mr. Fitzpatrick expounded that the fourth scenario was another end of field life modification. The scenario applied to fields where additional capital expenditure was required to increase production and the capital investment would be uneconomic without the modification. It was very similar to the second scenario but instead of increasing operating costs it was an increase in capital expenditures necessary to increase the life of the field. He delineated that the modification was only allowed for the net profit share rates and the provision was added in the House Resources Committee version committee substitute (CS). Co-Chair Merrick indicated Representative Rasmussen and Representative Carpenter had joined the meeting. 9:10:02 AM Representative Johnson wondered how many fields the legislation would apply to. Mr. Fitzpatrick referred to slide 8 that listed the fields that currently had net profit share leases within the unit. He listed the fields as follows: Collville River, Oooguruk, Nikaitchug, Kuparuk River, Duck Island, Point Thompson, and Milne Point. He noted that from a straight eligibility standpoint anyone of the fields could potentially apply for a modification. He expounded that most of the leases were currently in production already and likely would not see a modification for new production. He deduced that applications for modification would likely come from fields at the end of their production life for some of the smaller fields. Representative Johnson understood Mr. Fitzpatrick's response. She inquired whether there were fields the department was aware of that would likely come online within 3 years that were not end of life fields. Mr. Fitzpatrick thought that she was referring to Pikka and Nikaitchug North fields. He suggested that there might be an application for a royalty modification but not a net profit modification. He noted that Nikaitchug North was a federal field and decisions regarding royalties were made on a federal level. He speculated that under the fourth scenario some Milne Point and Duck Island fields might apply. 9:14:39 AM Mr. Fitzpatrick moved to slide 22 titled Eligible Scenarios for Modification. He deferred to his colleague to describe the modeling work on the following two slides. 9:15:04 AM JHONNY MEZA, COMMERCIAL MANAGER, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES (via teleconference), indicated that the slides showed a graphic presentation of eligibility for the 4 modification scenarios. He highlighted that the beige colored section of the graphs represented development costs and the investment and operating costs were depicted in light gray. In addition, revenue was portrayed as triangles and operating profits in circles associated with a hypothetical project. The royalties to the state were portrayed in dark gray, net profit share in light orange, and a proxy for production tax was shown in blue. He noted that proxy was based on the field level versus the production tax that was accessed on the taxpayer level. In the case of new production shown on the left graph on the slide, it was assumed in year zero, the lease holder had not yet decided whether to invest and obtain production from the oil and gas pool. If it was determined to be uneconomic unless modification of royalty or net profit share was applied the resources would remain stranded and potential state revenues would not occur. He turned to the second scenario [extended production] in year 17, after production for 16 years it was determined that continued production would translate into operating losses, modification of reduction of royalty or net profit shares could prevent the abandonment of the field by year 18 and ensure production and state revenue would continue. However, when evaluating the production in future years past performance of the field did not influence the lease holder regarding whether to continue production. He turned to slide 23 with the same title as slide 22 and continued with the remaining two scenarios. 9:18:14 AM Mr. Meza continued with the third scenario [restore production] in year 21 where production from the pool had ceased. However, with a modification, production could resume if it was technically feasible. He examined the graph on the right depicting the fourth scenario from the original version of the bill. He explained that HB 81 created a fourth scenario. The lease was in year 15 and the lease holder was considering a capital investment to a producing field to access incremental production that would extend the life of the field, stem or reverse the decline rate through enhanced recovery program or drilling outside the boundaries of a known reservoir. He qualified that without modification of the royalty or net profit share the capital investment might not occur. He reiterated that the committee substitute only allowed for modification of the net profit share and excluded royalty modification. He pointed out that the lease holder would not qualify for the first three scenarios under the royalty modification statute. Scenario A was disqualified because the pool was already producing. He added that scenario B would not qualify because the lease holder had not yet incurred the capital expenditures and could not yet claim that per barrel costs were increasing to the point of abandonment. He restated that the original version of HB 81 proposed that both royalty and net profit share could be modified. 9:20:29 AM Representative Josephson cited the CS and asked if the original bill would have allowed for royalty adjustment for Prudhoe Bay itself. Mr. Meza responded that the existing statute allowed for the modification of royalty for any lease that had a royalty component, for every state oil and gas lease. The applicant needed to make a clear and convincing case that the modification was warranted from an economic standpoint in order for the department to make any modifications. Representative Josephson understood that the amendment reflected on page 2 of the CS, restricted royalty modification that was allowed under the original bill. He asked whether he was correct. Mr. Fitzpatrick responded in the affirmative. The original bill mimicked the statutory language that applied to all the first three scenarios. He reiterated that the CS pulled out the royalty modification in scenario 4 and only allowed for net profit share modification. 9:23:07 AM Mr. Fitzpatrick advanced to slide 24 titled Decision- Making Process. A. HB 81 does not propose to change the modification process. B. A producer applying for a royalty modification must provide a clear and convincing showing that they meet the statutory requirements. ? A higher standard of proof than required for most other DNR applications. ? Applicants required to provide abundant evidence to justify any request for relief. C. DNR may require (for .180(j)(1)(A)) or request (for .180(j)(1)(B)(C)) that producers pay up to $150,000 per application for consulting work to support DNR's evaluation of the application. D. Publication of Best Interest Finding and offer presentation to Legislature (AS 38.05.180(j)(9) (10)). E. If granted, modifications are not transferrable without the authorization of the Commissioner. (AS 38.05.180(j)(5)). Mr. Fitzpatrick emphasized that the modification application process was held to a higher standard and was unchanged in HB 81. The clear and convincing standard applied to both types of modifications - royalty modifications and net profit sharing modification. He elaborated that the external consulting fee allowed the Department of Natural Resources (DNR) to obtain consulting services for scenarios of understaffing due to vacancies or lacking the necessary expertise to review an application. The external consultant participated in the review process for both types of modifications. He furthered that after a modification review, the department published a best interest finding that contained the justification and decision and was subject to a public comment period. During the comment period, DNR was required to testify before the legislature to discuss the decision. The requirement remained unchanged in statute. Finally, if a modification was granted under current statute, the modification was not transferable without prior written approval by the commissioner of DNR, which applied to both modifications. 9:28:53 AM Mr. Fitzpatrick indicated that the final portion of the presentation contained tables that were side-by-side comparisons of the original version of HB 81 versus the committee substitute beginning on slide 26 titled HB 81 vs. CS for HB 81. He offered that the original bill and CS both allowed for modification of net profit share under existing eligibility scenarios for royalty modification and clarified that the condition of prior production refers to commercial production. He noted that the language in the CS that created a new eligibility scenario for modification when additional capital expenditures were needed was refined by Legislative Legal Services. He reminded the committee that the CS restricted applicability of the new scenario only to net profit share modification. 9:30:13 AM Mr. Fitzpatrick briefly described slide 27. He commented that language included in the CS regarding the modification of the net profit share provided a floor of 10 percent, the modification could not be less than 10 percent. There were additional requirements for the new scenario. He explained that the capital expenditure had to be made by the lease holder or the modification would lapse and the commissioner of DNR had to approve the additional capital investments based on the need to maximize economic production. He noted that the conditions were typical for a DNR modification. He referenced the most recent modification from 2014 for the Oooguruk formation. He delineated that one condition lapsed the modification if the operator did not make the investment by a certain time. In the case, the modification lapsed and voided because the investment was not made. He believed that the conditions encapsulated best practices. He added that Legislative Legal also suggested other conforming language changes. 9:32:43 AM Co-Chair Merrick asked for the justification for removing the royalty modification. Mr. Fitzpatrick responded that there were some concerns about extending royalty modifications to larger fields. He communicated that the department viewed the royalty modification useful but understood it was a matter of legislative policy. 9:33:47 AM Representative Josephson suggested that because the changes were historically infrequent, he wondered why the legislature would not be given the opportunity to approve modifications. He noted that a modification was granted for the North Star unit via legislation in 1996. He relayed that the legislation moved quickly through the legislature and doubted delay would be a problem. He wondered what the department's position might be. Mr. Fitzpatrick was unable to speak to the departments position. He acknowledged that the legislature had approved modifications in the past. The current modification statute allowing the commissioner to approve modifications was in place for the previous 26 years. He would follow up on the representative's question. Representative Josephson would appreciate the information. Representative Rasmussen did not believe the legislature would be able to move quickly on any legislation under the current political environment. Mr. Fitzpatrick thanked the committee for hearing the bill. Co-Chair Merrick set the bill aside. HB 81 was HEARD and HELD in committee for further consideration.