HB 276-OIL/GAS PRODUCTION TAX CREDITS: NENANA  1:58:21 PM CO-CHAIR FEIGE announced that the next order of business would be continued discussion on HOUSE BILL NO. 276, "An Act providing for a credit against the oil and gas production tax for costs incurred in drilling certain oil or natural gas exploration wells in the Nenana Basin." [Before the committee was Version M, the proposed committee substitute (CS) labeled 27-LS1193\M, Bullock, 1/18/12, adopted on 1/30/12.] CO-CHAIR FEIGE invited the sponsor to discuss points that were brought up in meetings on 1/31/12. 1:58:39 PM REPRESENTATIVE STEVE THOMPSON, Alaska State Legislature, sponsor of HB 276, related that there have been ongoing discussions with the Department of Revenue (DOR) and the Department of Natural Resources (DNR). He said that DOR and DNR are looking at how this tax credit would fit with existing tax credits and will be getting back to him on [2/6/12] with additional information. One possibility being looked at is expanding the bill to cover regions that are underserved and suffering from high energy costs. 1:59:37 PM JANE PIERSON, Staff, Representative Steve Thompson, Alaska State Legislature, explained that one of the most interesting things discussed yesterday was that these are wildcat basins with a low potential - 5 to 15 percent - of success. So, a three-step process was looked at, the first being seismic exploration which would be shared with the state. The seismic data would increase the odds for success and would be valuable to the state to have. The second step would be pre-qualification for the drilling incentive from the Alaska Oil and Gas Conservation Commission (AOGCC) and DNR based on the seismic data provided. The third step would be the drilling and the issuance of the credit. Given that "the devil is in the details," work will continue on making all the pieces fit together so that the tax credits work smoothly with those that are already on the books and get to the sponsor's intent. 2:00:54 PM REPRESENTATIVE THOMPSON explained that by the pre-qualification, DNR and AOGCC would have to determine that something does have a potential that is worthy of drilling. They could disallow the credits for drilling on a location that does not have much potential, which could save the state a lot of money in the long run from a total wildcat of just going out and drilling a hole. 2:02:00 PM CO-CHAIR SEATON pointed out that the 40 percent exploration tax credit would still be applicable, so somebody wanting to proceed with a well that did not qualify for this [proposed] enhanced credit could still take the existing credits, which are substantial. For locations that are over the distances away from someplace else, there is the 40 percent tax credit, plus conversion of the cost at 25 percent to a credit, thus basically it is 65 percent of the well cost as long it is within those parameters. He said he is just clarifying that the pre- qualification is only for this [proposed] enhanced credit. 2:03:36 PM REPRESENTATIVE HERRON observed that there are the Cook Inlet credits and now there is this legislation for credits for the Nenana Basin. He asked whether this discussion is leading to the creating of a template so that some other basin in the state does not have to come back to the legislature. REPRESENTATIVE THOMPSON responded yes, he is looking at other basins and possibly regions, but he has not yet put it all together. 2:04:34 PM REPRESENTATIVE KAWASAKI commented that gas-starved Fairbanks is looking for energy solutions, and while this is the appropriate committee in which to debate a statewide policy, he does not want to get caught in the weeds. Fairbanks and other places across the state have been struggling to have something effectively passed and he would like to see the questions, especially on the pre-qualification, answered sooner rather than later. 2:05:22 PM CO-CHAIR FEIGE recognized that HB 276, as currently written, would apply incentives directly to the Nenana Basin alone, but said he would like to step back and look at the state overall and the incentivizing of oil and gas and get a feel for the committee's basic philosophy for what should be done here. He said he would like to ask five questions, with the first being whether it is appropriate to further incentivize oil and gas exploration above and beyond what is already on the books. REPRESENTATIVE GARDNER responded that she has a concern any time it is a 100 percent incentive because it molds behavior in ways that are not always beneficial. REPRESENTATIVE KAWASAKI recollected that many of the exploratory and production wells shown on the map from the Division of Geological & Geophysical Surveys are centered in two basins. The city of Fairbanks is far away from those two basins and that puts Fairbanks in a poorly placed strategic area. However, as a state he thinks Alaska ought to be wildcatting because pretty much every hole ever drilled was a wildcat hole at one point in time, including the Prudhoe Bay and Cook Inlet areas. So, there is cause for it, he agreed. REPRESENTATIVE HERRON, looking at Mr. Swenson's PowerPoint of all the basins that have potential, said he agrees with Representative Kawasaki. The Yukon-Kuskokwim Delta has low potential for a big producer, but it has significant potential for local use. He said he therefore thinks it is the committee's responsibility to discuss that policy. 2:08:41 PM REPRESENTATIVE P. WILSON concurred, but questioned how something found in the middle of nowhere will be taken out of there. For areas along the pipeline the product can be taken out, but for [remote areas] it will cost the state or somebody a lot of money once it is found to build a pipeline or a road. She added that she firmly believes in developing ways to get to the state's resources, and building infrastructure is probably the number one thing the state should be doing. She said she does not know how to connect the dots at this point, but it is something the committee needs to deal with. REPRESENTATIVE THOMPSON pointed out that he did not intend for this to be something for export. He is looking at it as a way to bring relief to depressed areas and remote areas of the state. It would bring down their costs which would save the state millions of dollars in power cost equalization. REPRESENTATIVE P. WILSON surmised that [the gas] could not be used as it comes out of the ground and would have to be refined. She asked what would therefore need to be done to help a community. REPRESENTATIVE THOMPSON, qualifying that he is not a gas person, related that Cook Inlet gas is very dry and can nearly be used right out of the ground, while North Slope gas is very wet and has to be cleaned before it can be used in a home furnace. He allowed that there are differences and it depends on what is found as to whether it will need to be processed to be usable. CO-CHAIR FEIGE commented that it will not be known until the gas is found. 2:11:38 PM CO-CHAIR SEATON cautioned that he does not want the idea to be that it is just small basins with small quantities of gas that can be used only there. For example, natural gas found in the Copper River Basin would provide a ready source of gas to heat the oil in the Trans-Alaska Pipeline System (TAPS) to overcome some of the pipeline's problems; the same thing for any extra gas in Nenana. The Donlin Creek Mine is projecting to have usage greater than what the entire Railbelt and Southcentral are using right now, so in-state usage does not mean it has to be small. Depending on the quantity found, the gas could allow other economic bases in those areas to flourish as well. Most of what is being thought about is natural gas, but there could be oil in the Nenana Basin just as well as gas. CO-CHAIR SEATON added that a bill by regions would get beyond the idea of a bill for just one group that has a license for an area. He said he wants to make sure the bill is expanded beyond [the Nenana Basin] so that it has general statewide implications. In response to Co-Chair Feige, he confirmed he is meaning for Alaska as a whole. 2:14:18 PM REPRESENTATIVE KAWASAKI, regarding pre-qualification, stated that if the bill is expanded as mentioned by Co-Chair Seaton, thought needs to be given about anchor tenants and how to get that gas to market. The exploration credits on the books have done their job, but the problem has been with production and the realization of a project. He said he does not want to see a bunch of wildcat drilling without any results. The state's investment needs to result in gas production, not just exploration, and that should be part of the pre-qualification. 2:15:16 PM CO-CHAIR FEIGE said he thinks it is a general consensus of the committee that some kind of incentive should be provided, but that members do not want to pay 100 percent just to punch holes in the ground. Even though the state is bringing in revenue it does not have enough money to punch holes all over the state to find the resource, so a way must be found for getting someone else to pony up the money and that is a delicate process. Therefore, the question for the committee is what the best way is to incentivize that. Given that the average wildcat well has only a 10 percent chance for success, he requested Mr. Swenson to address how the risk of drilling a dry exploratory well could be lowered and how the state could improve the information that it has through a program of incentives. 2:17:27 PM ROBERT SWENSON, Petroleum Geologist, Acting Director, Central Office, Division of Geological & Geophysical Surveys, Department of Natural Resources (DNR), began by clarifying what wildcat and chance of success mean. A prospect said to be a wildcat prospect means that the amount of information that is had is relatively limited, so the chance of geologic or economic success is always based on just that one well rather than the entire basin. Every piece of information gathered is incredibly important because each piece provides a better understanding of what is in the subsurface, which increases the chance factors. It is not that all of these basins have a 5-15 percent [chance of success]; rather, it is that there is very little information for most of these basins. As additional information is gathered the chance factors will either increase or decrease. An example of this is Nenana Basin in which the explorer is very far down the exploration road in comparison to Minchumina Basin which has only gravity data and no subsurface information whatsoever. The Minchumina Basin is truly wildcat and drilling a well there would be incredibly difficult because it would be hard just placing where to go to get the most information. 2:19:29 PM MR. SWENSON continued by pointing out that it is a difficult process to combine all of this together and have a template in which each basin is played the same way. The issue is to understand the data that is there and to understand what the prospect is. He said he thinks it important that the state understand what is available to it as far as the geology and the petroleum potential; it does not mean that that will take it all the way to production, but it is understood what is available from the standpoint of resources, and this is what is important about this discussion and HB 276. Unlike many other states, Alaska has a lot of geology that is conducive to both oil and gas and minerals. He reiterated that the Nenana Basin is much further along than most of the other areas because it has a lot of seismic, three wells, and a lot of subsurface information. 2:20:56 PM REPRESENTATIVE GARDNER, in regard to gathering information on broad areas, asked whether it would make sense for the state to do seismic work and then make it available to potential bidders, thereby increasing the value, potentially, of lease sales. MR. SWENSON responded that how data is acquired is what he thinks this discussion is about, whether the state subsidizes or provides tax credits or some other process. Whether it is seismic data, gravity information, shallow core holes, or deep wells, each piece of information would help develop the model of what is there. For example, take away all the wells and seismic from the North Slope and think about when Prudhoe Bay was discovered. Nine wells were drilled in that region and the first eight were dry, but each well provided additional information. The target being drilled for at the time was the Lisburne, a carbonate rock beneath where the oil was actually found. When the Sadlerochit was hit, which is Triassic in age, there was absolutely no idea that this rock formation was going to be the target, and it is unbelievable how many times that type of thing happens. Going back from that serendipitous event, the issue is that it was known from the other wells that there was a lot of potential because of the active hydrocarbon that was found, along with a lot of shows and the thermal history. Much of the picture was put together and all of the pieces were there, but the picture was incomplete. When the Sadlerochit was hit and Prudhoe Bay found it was a complete surprise. That same process must be gone through to evaluate any one of these basins. It will be unknown what is actually there until it is hit and produced, but the ability to understand it increases with each piece of data - so any piece of data is important. 2:23:46 PM CO-CHAIR FEIGE inquired whether it is fair to say that the more information available to a potential investor, the higher the likelihood that a potential investor will make that investment. MR. SWENSON replied correct, but stressed it is specifically the basin that is being talked about. Then what must be taken into account is what infrastructure is available and how the product will be taken to market. Sticking with just the basin, he continued, the more data that is positive information, the better the chance of bringing an outside investor into that basin. The Nenana Basin has a significant amount of data. 2:24:50 PM CO-CHAIR FEIGE presumed that the state's data is primarily stored with the Division of Geological & Geophysical Survey. He asked whether the division has an inventory of what data is available where in the state. MR. SWENSON answered yes, and added that a number of different agencies have various types of data. The Alaska Oil and Gas Conservation Commission (AOGCC) collects all the well logs and samples from any of the oil and gas drilling in the state. The Division of Geological & Geophysical Survey gets those samples after they have become public; the division does not house any confidential information whatsoever. The Division of Oil & Gas (DOG), specifically DOG resource evaluation, and the AOGCC have a significant amount of seismic data that is proprietary because statute requires that it be turned over to the state. Some of that data becomes public after a period of 2-10 years, and once that is made public the Division of Geological & Geophysical Survey has access and can publish it, along with maps, to help people understand the geology and to facilitate exploration. CO-CHAIR FEIGE surmised that the confidential seismic data made available to the state is data that the individual companies themselves are paying the cost to acquire. MR. SWENSON responded correct and noted that some of that data never does become public. 2:26:24 PM REPRESENTATIVE GARDNER inquired whether seismic data that was publicly available for a lease would tell an adjoining leaseholder anything about that leaseholder's nearby land. MR. SWENSON said there are two levels of understanding. One is regional and tells what the basin is doing - what temperature it got to, what the basin's history is. This upfront information would definitely help that person with an adjoining lease block in understanding the basin. However, the second level of understanding is where to specifically put down an 8.5-inch bit into a very expansive area, and the cost of getting it there is high. That is why such a tremendous amount of three-dimensional seismic is being shot now - it gives that much more information and helps to focus in on a very, very small target. For this level, an adjacent line in another area will probably not help, but for an understanding of the basin it will. 2:27:52 PM CO-CHAIR FEIGE related his experience in seeing the great advancements that have occurred over the years in the quality of, and the means for gathering, seismic data. He asked what the most cost-effective means would be for the state to delve into to overview what a basin is really like. MR. SWENSON concurred that the seismic data and all data acquisition technology has changed in leaps and bounds. He advised that [the state] is facilitating something everybody wants - the explorers want to find something, the state wants the explorers to find something, and the Native corporations want those companies to find something. In that scenario there will be different ideas about what the best data is, but everyone wants to get the most cost-effective look at whatever it is they are trying to get at. For example, in Minchumina Basin where there is very little data, one or two regional seismic lines to acquire the basic basin geometry would probably work. Areas like Yukon Flats, Nenana, and Kotzebue already have significantly more data, so the next step in those places would be determining the most cost-effective piece of information to provide the next phase of understanding to prove up whether there is a petroleum system or trappable structures. Rather than the state being a gate keeper, it is more of a partnership for coming up with the best idea for evaluating the basin. 2:31:17 PM REPRESENTATIVE P. WILSON understood the state has lots of data but that some companies never give the state any data. She asked how and when the state acquires the information. MR. SWENSON qualified that he is not the best person to answer this question and said he will get back to the committee with a detailed brief in this regard. However, he continued, sometimes there are "spec surveys" where a seismic company shoots a huge area and then sells the opportunity to get that data with the stipulation that it cannot be passed on. He offered his understanding that for [spec surveys] on state land the state must get a copy and it is held confidential. Under certain scenarios, such as some incentive programs, the data becomes public after some period of time; for the licensing program he believes that time period is 10 years. Thus, there is a full spectrum depending on the location, the part of the confidentiality process, and how it is held. 2:32:55 PM REPRESENTATIVE DICK noted that a dry hole that costs $25 million to drill provides some data. He asked how the data from a dry hole compares to the other methods of gathering data. MR. SWENSON began his reply by comparing remote sensing to the medical world, saying that even with all the different types of imaging for looking into a person's body, it is still the surgery that ultimately shows what something actually is. Because drilling is the most expensive part of the process, he continued, it behooves a company to get information to focus where that drill should go and to have a fair understanding of the basin's geometries and how deep to go. However, the only ultimate understanding is actually drilling a well, and probably more than one well, because the chance of success for any one well becomes so low. REPRESENTATIVE DICK surmised that it might then make a lot of sense to drill maybe five holes in a basin. MR. SWENSON responded that sometimes by the fourth well it will be known that it is not going to work, and sometimes by the first well that will be known. "It really depends on where you are," he said. 2:35:21 PM CO-CHAIR SEATON noted that there are many basins across the state and therefore the state cannot put itself on the hook for every basin. He asked whether it would make sense to do this regionally and limit the regions and to have Mr. Swenson provide the contours for where those regions should be. MR. SWENSON answered that a key issue in drawing the areas is that a basin not be cut in half - that the differentiation be based on geology and not geopolitical surface issues. There will be some upfront knowledge about a basin to date, he continued. However, because the overall prospectivity of a basin will likely be relatively limited, it would probably be best to prioritize by identifying which has the highest potential from the geologic perspective of what is known, or that additional information is needed. A number of different variables will go into that equation. 2:38:14 PM CO-CHAIR SEATON understood Mr. Swenson to be saying that regional is not the way to go; rather, prioritizing the basins statewide is the way to go. MR. SWENSON replied that, in reality, the number of basins is less than 30, so it is important that [his division] get that information for the committee and then have the discussion again. For example, the Nenana Basin is a relatively small surficial area. It is important to look at which one of these basins maintains potential and to look at the area of extent of a basin with that potential, and to then have discussions. CO-CHAIR SEATON requested that Mr. Swenson provide the committee with a prioritization and an estimate of regional guidelines. He said this might be part of the pre-qualification information. MR. SWENSON agreed to do so. 2:41:21 PM CO-CHAIR FEIGE asked what kind of information would go the greatest distance in reducing the exploration risk that Doyon, Limited is facing with projects that are currently underway [in the Nenana Basin]. JAMES MERY, Senior Vice President, Doyon, Limited, stated that there are a couple of difficulties. Because these frontier basins are not Cook Inlet or the North Slope the majors perceive them as too small, while people Outside see Alaska as scary; so it is a difficult environment. One helpful thing is that in some of these basins the oil potential has gone up substantially through Doyon's work. However, Doyon is losing partners in this venture, not gaining them. Doyon drilled a well and gained some valuable data even though it was not a productive well in terms of commerciality. The data from that well heightens the promise of these Interior basins. Doyon is undertaking its own seismic program right now because it is a strong believer in the area's promise, but most of its other partners in the Nenana Basin are not participating in that project. MR. MERY noted that it all comes to a head at the next stage, which is drilling. It will take at least two more wells, and maybe five, to know what is out there and getting to that point is going to be very difficult. Doyon is not in a financial position, even after it shoots the seismic, to fund 100 percent of a well that may be drilled in the future. The state has been a welcome partner through the other programs, he said, and what Doyon is looking for here is for the state to be a little bit more of a partner so that Doyon can get over the next hump to move this project forward. 2:44:59 PM REPRESENTATIVE GARDNER inquired about the cost for Doyon's last well and the anticipated cost for the next wells. MR. MERY answered that Doyon's last well was a summer time operation within a few miles of the road system and the costs were a little south of $19 million. According to a recent Doyon study, a 12,000 foot well in summer time, and without pre- contingencies, will likely cost a little over $25 million completed. 2:46:05 PM CO-CHAIR SEATON related that since the Norway policy tour there has been a fair amount of interest in the legislature about state direct financial investment (SDFI), which is like a working interest owner. He asked whether Doyon would find it appealing to have the state as a working interest owner in the 20-25 percent range. He noted that a couple of different models have been run, including one model by Pedro van Meurs which found that the fiscal system could be made more attractive by converting the 12.5 percent royalty to a 25 percent SDFI. Another scenario is to leave the royalty as is and have some SDFI. MR. MERY responded that Doyon has had no discussions and has not given any thought to it, but he is aware of what Mr. van Meurs has talked about. While there have not been formal or direct talks, he said he is sure that Doyon would be open to it. REPRESENTATIVE DICK commented that the two things driving where the drilling takes place are how good the basin looks and how desperate the market is, and that is what makes the Nenana Basin so compelling. 2:48:50 PM REPRESENTATIVE P. WILSON inquired whether Doyon would be able to get investors to come back after there is more seismic data that indicates where the best place is to drill the next well or wells. She allowed this would depend on what the seismic finds. MR. MERY replied that the objective is to drill wells and that with success he thinks Doyon would have no problem attracting new investors. The next biggest risky part of a venture in the Nenana Basin is drilling in the central part of the basin, and investment will follow quickly once it is established through discovery that there are many things to chase out there. 2:50:15 PM CO-CHAIR SEATON related that the bill's structure of 100 percent has created a lot of consternation. This has resulted in discussions about 80 percent on all three, given that [HB 276] has no differentiation between the first, second, and third well like there was in the Cook Inlet issue. The committee is wrestling with how to structure a bill: one structure being an 80 percent tax credit with a payback of half of that amount if there is profitable production; the other structure being the current 40 percent exploration tax credit and 25 percent conversion of expenses to a transferable tax credit. He asked how Doyon would evaluate these two structures of credit. 2:52:20 PM MR. MERY answered that it becomes a harder question for Doyon. Addressing it from the standpoint of previous committee discussions about "no skin in the game," he explained that the Cook Inlet legislation has a 90 percent reimbursement across three wells, with an up-to-$25-million cap on each well. A 90 percent credit across three wells - the first, second, and third wells - would work quite well for Doyon. As far as skin in the game, he said Doyon's cost estimates are a little bit north of $25 million. If anything goes wrong and it costs $30 million, Doyon will only get reimbursed for $25 million, not $30 million, so Doyon is holding the insurance policy on cost overruns. Additionally, it is likely that later this calendar year Doyon will have to convert its license to leases, and then Doyon will have to write checks to the State of Alaska every year for about $1.5 million just to hold the leases. On top of that, Doyon is now spending money on doing seismic. Also, while drilling, it would be Doyon's intention to do more seismic on the southern end of the basin. The legislation that would allow Doyon to drill these things with these enhanced incentives really just triggers a whole lot of other things that will happen, and in that respect Doyon certainly has a lot of skin in the game. The notion of having the Division of Oil & Gas involved and perhaps pre-approving some of this does not trouble Doyon and Doyon welcomes that because it has an open relationship with both Mr. Swenson's division and Mr. Barron's division. Doyon has shared a lot of information that it did not have to share because it wants the participation and input of those divisions. 2:55:09 PM CO-CHAIR SEATON, regarding the sharing of information, explained that one concern about enhanced credits was that the state should get something for that. The data would be available to the state without a long restriction on time limits because it is all under license which can be converted to leases and is therefore not competitive. MR. MERY replied, "No problem with that at all." 2:55:49 PM CO-CHAIR FEIGE stated that in the course of discussion the committee has gone over the rest of the questions that he had. If the committee decides it is going to incentivize and it determines exactly how it wants to incentivize, his last question is whether those incentives should be made open ended or only available for a fixed period of time. If it is open ended that becomes the state's basic structure, while a time limit might force people to respond to the state's desire to have more exploration sooner. 2:56:51 PM REPRESENTATIVE KAWASAKI said his comments are not to the timeline, although he thinks it would be a good policy for the committee to make. Continuing, he noted that there is a limited amount of money but lots of potential areas to explore. Regarding the limited amount of money, the politics are that everybody wants to add his or her area into the whole equation and he wants to make sure that it does not become so large that the committee cannot figure out what to do. In prioritizing the basins, he would like to come up with a policy that is fair. CO-CHAIR FEIGE, in regard to taking the politics out, commented that some entity has to make a decision about where. He asked where the appropriate place is to have that decision made. REPRESENTATIVE KAWASAKI responded that on the policy side he wants to make sure the committee does not pigeon it so much that it helps one group or another, which has been seen too many times. 2:58:43 PM REPRESENTATIVE GARDNER, responding to Co-Chair Feige's question about the length of time, said the benefit of a time limit is that the legislature can always extend it if it is successful. CO-CHAIR SEATON pointed out that the information on some basins is much farther along than that on others; for example, the Nenana Basin has seismic being shot and other development, so it is hard for something else to catch up. For people willing to drill in basins, the Nenana is well on its way. He said he thinks the committee is waiting for Mr. Swenson to come back with those prioritizations and some kind of regional mix. Regarding a timeline, he said it takes time to develop these sorts of things, so it could become problematic for a company trying to develop something because the company would not know whether that incentive would still be there. Additionally, if the committee was to look at a state direct financial investment (SDFI) model, then it would probably want restrictions based not so much on timelines, but on newer fields not going in and taking that kind of position and an old field where it has mostly been produced because there are liabilities to being a working interest owner, such as liabilities for oil spills. 3:00:42 PM CO-CHAIR FEIGE held over HB 276.