HB 276-OIL/GAS PRODUCTION TAX CREDITS: NENANA  1:46:45 PM CO-CHAIR FEIGE announced that the final order of business would be 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 the proposed committee substitute (CS), Version M, labeled 27-LS1193\M, Bullock, 1/18/12, adopted on 1/30/12 as the working document.] CO-CHAIR FEIGE noted that HB 276 has generated much discussion between the committee, the sponsor, and the Department of Natural Resources (DNR) as to the best overall way to proceed. He drew attention to the [2/16/12] discussion document prepared by DNR included in the committee packet, and pointed out that the document does not constitute an endorsement of the legislation by DNR. He added that before any amendments are brought up, he would like to have a fair amount of discussion on the general concept and determining the best ways to proceed if this is to be applied to more areas of the state than just the Nenana Basin. REPRESENTATIVE P. WILSON offered her appreciation to DNR for providing the discussion document, saying it is much better to prevent any unintended consequences than to have to deal with them later. 1:49:09 PM JOE BALASH, Deputy Commissioner, Office of the Commissioner, Department of Natural Resources (DNR), noted that the discussion document and associated map have been provided to the committee, the bill sponsors, and others in an effort to help policy makers make informed choices about the consequences of the particular policy calls the committee is being presented with. He said the department is not endorsing legislation of one sort or another since that is a policy call by the governor's office. However, because some of the dollars being considered could be quite large, DNR thought it important to lay out as much as possible in the discussion document. The document includes suggestions on things to consider for defining the scope of the incentive and, in particular, the kinds of things that the state should expect to get for making such a large investment in something that is, by definition, not otherwise able to attract private prudent investors. The department believes certain pre- qualification steps would be helpful to ensure that the exploration programs in question make sense and are designed to recover information that would be of value not just to the individual investors or companies, but also to the state and the public. 1:51:14 PM MR. BALASH, in regard to drilling the wells and the type of information being gathered, said it needs to be ensured that there is a full suite of data collection, that this is performed by the driller, and that it be turned over to the state for full public release before the credit is earned. He pointed out that this is different from some of the other exploration incentive credits the state has had before in that those required the data to be held confidential for a fairly long period of time. However, those were for smaller credits not nearly as valuable as the ones presently being contemplated. 1:52:20 PM MR. BALASH addressed the map accompanying the document entitled "Regions for Potential Frontier Basin Oil and Gas Exploration." He said the map represents a high level screening of basins in the state that are within some reasonable proximity to either existing infrastructure or populations. The map identifies oil and gas, population centers, and the amount of energy used in each community; proximity to mineralized zones was not included to avoid the map becoming too busy. He added that the document captures some of the things spoken to by Mr. Swenson and Mr. Barron, and that Mr. Paul Decker, Resource Evaluation, Division of Oil & Gas, assisted with the document. He noted that all three gentlemen have spent considerable time in the private sector working for exploration companies and that they helped think through the things that would be of value to the state if these types of programs are put into place. 1:54:39 PM REPRESENTATIVE FOSTER surmised that the waters south of Nome in Norton Sound are not included on page [2] in the list of eligible areas for geophysical and/or drilling credits because they would be federal waters. Observing symbols on the map, he asked why the Nome area was not considered eligible for geophysical or drilling credits. MR. BALASH explained that the symbol next to Nome represents the amount of heating oil and diesel consumed by the community, not the area's oil and gas potential. He agreed that in particular there is potential for gas offshore south of Nome, but said that at this point in time the federal government has not seen fit to share those particular revenues with the state. He added that he thinks it would be difficult to get permits anyway. 1:56:38 PM REPRESENTATIVE FOSTER understood that the [potential] onshore sources of gas [near Nome] are in very thin layers and therefore production from such a source would be unlikely. He asked whether those areas could nevertheless be included for credits because something new might be found down the road. MR. BALASH responded that the document attempts to stratify the basins identified in terms of those that would warrant a seismic exploration program versus a drilling program. He said the smaller or thinner the accumulations the less helpful seismic is, but that he will talk to his staff about the relative merits of authorizing a seismic program in that area. 1:58:09 PM MR. BALASH returned to his review of the discussion document and stated that it might be constructive to talk about possible mechanisms for constraining the program in a fashion that makes sense. While DNR's pre-screening effort has identified particular basins, a three-well program like that authorized for Cook Inlet, which is $65-$67.5 million, would be a big number when multiplied by nine basins, and the heavier a bill gets the harder it is to move. An approach to this particular problem might be to authorize a certain number of wells within these frontier basins statewide on a first-come, first-served basis. So long as there is a reasonable limit on the credit amount itself, the private sector "skin in the game" will help limit, naturally, the number of wells that will be drilled under the program. The legislature could further set out how many wells per year or how many wells per basin, and in that fashion keep the legislature fully in charge of how many of these wells might get drilled that are expected to have a very low probability of success in reaching a technical resource, let alone an economic one. 2:00:12 PM CO-CHAIR FEIGE commented that from the standpoint of data collection a lot would be learned about the relatively unexplored areas of the state if everyone showed up at once to take advantage of the credits; however, that could also cause the state to run out of money. He asked whether Mr. Balash has a suggestion for a way to entice people to sign up for the program realizing that the state might not have enough money to deliver on the credits right away. MR. BALASH replied that one way might be to have a separate credit refund bucket. Currently, credits under the production tax can be realized by the taxpayer when there is production or when there is no production tax liability the taxpayer can go to the Department of Revenue for a refund, in essence. Right now, the legislature funds that refund fund annually with an estimate provided by the Department of Revenue. If the legislature wanted to have a separate bucket within that fund for these types of credits then the legislature would be able to keep a handle on how much money would be available, and that could limit the number of efforts that are undertaken, in a manner of speaking. However, if it is broadly authorized under the production tax code and subject to realization or refund as something just on the books, then there may be a number of underemployed consultants and geologists, he quipped, who could justify a given program for the free money. 2:03:41 PM CO-CHAIR FEIGE reiterated this same question for the Department of Revenue regarding a mechanism that could or should be considered to pay for a future exploration program. LENNIE DEES, Audit Master, Production Audit Group, Tax Division, Department of Revenue (DOR), answered that the mechanism to do that would be to ensure that anybody going for the credit has a duty to perform certain actions, such as the information sharing and ensuring that feasible targets are being sought, not uneconomic exploration plays. Putting those requirements into the program would tend to limit people from doing something that they otherwise would not do if they had to spend their own money. 2:06:23 PM CO-CHAIR FEIGE asked whether 75 percent is a reasonable amount of subsidy, which is a 10 percent increase over what the state currently has in place. MR. DEES responded that he thinks what is in place now is reasonable, which is that companies can get up to 65 percent through combination of the credits and the carry forward loss credit. He said 75 percent adds a little bit more pain to the state from a cash flow standpoint, and he thinks that that would be the limit. 2:07:23 PM REPRESENTATIVE P. WILSON understood the recommendation being suggested is to set limits on the number of projects and wells allowed in each area. She recalled that for Cook Inlet the legislature limited it to the first person to get jack-up rigs into the inlet and asked whether this is what is being suggested. MR. BALASH replied that the jack-up rig credit was designed to attract a specific piece of infrastructure and equipment that was creating an obstacle to further exploration in Cook Inlet waters. He noted that those waters are largely state leases that will pay a royalty to the state, and the credit amounts and percentages are incredibly high. However, the efforts that would be undertaken [through HB 276] would be entirely onshore with equipment that is already in the state and that could probably be used at times of the year when rigs cannot be employed on the North Slope, which is currently winter-only exploration. Therefore, it is a different set of considerations between Cook Inlet and here. Because most of the areas here are remote and it will be very difficult to move equipment in and out of them, DNR has tried to balance the required depth for drilling and the information that is required to be collected. 2:09:59 PM MR. BALASH, continuing his answer, said it is a tricky balance in regard to the overall percentage because in some areas of the state there are companies that do not pay federal corporate income tax. When dealing with a federal taxpayer that enjoys a 65 or 75 percent credit from the state plus the benefit of the federal right-off and right-down, there is a loss of that skin necessary for people to make what is hoped to be sound decisions. For this program to be of benefit to the public, the result needs to be information that is valuable to the state or a resource that can, at a minimum, be used locally. Thus, some semblance of a profit motive, so to speak, needs to be retained. That difference between the suggested 75 percent rate for coverage here versus the 180 [percent] with Cook Inlet is because this is a little bit different animal. 2:11:42 PM CO-CHAIR FEIGE inquired when, under the current system of incentives under AS 43.55.025, the required geophysical data is made public. MR. BALASH offered his belief that it is a 10-year term from the time that data is acquired to when it is made public. CO-CHAIR FEIGE said that that is a significant delay even though it was subsidized by the state, but for an extra subsidy in this case that data could be made public sooner. MR. BALASH answered correct; the Division of Oil & Gas has a collection of geologic and subsurface information that is sitting on the shelf waiting for the clock to turn. 2:12:38 PM CO-CHAIR SEATON observed that in the committee's consideration of HB 276, the direction of the bill has been changed from a single basin to a basin-opening concept. He noted that the state currently has a 65 percent credit through the 40 percent exploratory tax credits under AS 43.55.025 and the 25 percent in loss carry forward conversion. Given that 75 percent is being considered for the bill, he surmised that it might be cleaner to write it as a 10 percent basin-opening credit on top of what people can already do. It is risk capital because these are risky things and the state would be getting the information, but the 10 percent basin-opening credit would be limited to so many wells in each basin with prior DNR consultation. He asked whether such a system would provide enough control over this program. MR. BALASH replied he is not trying to dodge the question, but that it should be addressed by the Department of Revenue in terms of administration and whether it would be another layer of complexity that is hard to explain or whether it would be better to have something that stands alone to which regulations can be applied separately. He further suggested that the question be asked of the landowners and operators who have appeared before the committee. He understood that the players in question have run into difficulty attracting capital and if it is presented in one way or another it might help or hinder them. 2:15:36 PM CO-CHAIR SEATON noted that there is differentiation between the amounts of credit under AS 43.55.025. The problem is that an existing producer with a high tax rate liability could get the 40 percent tax credit and if that producer's tax rate is 40 percent the producer could take that as a deduction from the expenditure plus the other on top of it, which would lose the concept of skin in the game. He said it would seem logical to say that when taking an exploration tax credit under AS 43.55.025 and the deductibility or conversion of expenses to loss carry forward, that that amount cannot exceed 65 percent. That would limit the state's liability to 65 percent on any of these basins and then the 10 percent on top as a basin-opening portion. He said he wanted to clarify this because he heard the worry of Mr. Dees about stacking credits too high and not controlling them, although 65 percent is not necessarily the rate because it depends on whether it is a producer or an explorer. He asked whether Mr. Balash agrees that this approach should be investigated. MR. BALASH qualified that his familiarity with the production tax program is from his time in the capitol building, not his time as an administrator at DNR. He said one way to achieve the control being described would be to disallow these qualified lease expenditures from being used as a deduction or a credit for anything else under AS 43.55; then a specific number could be designated that is intended for this program to cover. He suggested that Mr. Dees speak to the question. CO-CHAIR SEATON added that this needs to be explored so it is known what the state liability will be. 2:19:38 PM CO-CHAIR FEIGE said one of the committee's questions is the difference in return. Part of what Mr. Balash is suggesting is that the state receives a return for its subsidy and one return under HB 276 would be the geophysical data and a much earlier release of that data. He asked what the different returns to the state would be on any projects that go into production, given that three categories of lands may potentially be opened for exploration - federal, Native corporation, and state. MR. DEES responded that in addition to the information the state would receive from these activities, the state's revenue would increase from the collection of production taxes on a producing activity. Regarding federal lands, he said he is unsure what the arrangements are for sharing royalties with the federal government, but that the state would benefit from the throughput in the Trans-Alaska Pipeline System because it would lower the tariff that everyone pays. In regard to Native lands, the state would benefit from the production taxes. In further response to Co-Chair Feige, Mr. Dees said the state would not collect production tax from the federal lands, but the production would flow through TAPS which might lower the tariffs on state royalty barrels as well as the tariffs on the other production in the state. He said he is unsure about royalty sharing [from federal lands]. 2:23:12 PM CO-CHAIR FEIGE clarified that he is talking about onshore federal lands, not offshore. MR. DEES answered that in that case he believes onshore federal lands are part of the tax base. In further response to the co- chair, he confirmed that the state would receive production tax from Native corporation lands but no royalty, and said he is unfamiliar with Section 7(i) monies related to Native lands. 2:24:23 PM CO-CHAIR FEIGE, in regard to Mr. Balash's suggestion to speak to folks with an investment stake in this, asked how the aforementioned suggestion would be perceived by investors and the Alaska business community that is seeking investors. JAMES MERY, Senior Vice President, Lands and Natural Resources, Doyon, Limited, pointed out that this is the state's money and said groups like his are very appreciative of the relatively generous exploration credits currently in place. The initial notion in HB 276 was focused on state lands in the Nenana Basin and to get a lot done very quickly. The higher rate appealed to Doyon because it presented an opportunity to drill two to three wells in a row rather than having to wait two, three, or four years to get those wells drilled. It was a unique opportunity at that point in time and was, in effect, like the Cook Inlet jack-up rig situation because it was a unique circumstance that Senator Wagner and Representative Thompson wanted to address. However, with the discussion now broadened, he said he did not think the ability to drill three wells in a row at 65-75 percent would happen. While he did not want to diminish these wonderful credits, he said it was the special nature of finding out something about a basin that is very close to infrastructure and that could happen relatively quickly as compared to some of the other basins that are now being discussed. Doyon is happy with the 65 percent, he continued, but if the committee saw fit to move it to 75 percent because of the extra risk associated with most, if not all, of these basins, Doyon would just have to see how it works in the marketplace. 2:27:28 PM CO-CHAIR SEATON understood Mr. Mery to be saying that if it were like Cook Inlet with 100 percent state money on the first well, 90 percent on the second, and 80 percent on the third it would stimulate Doyon's wells to happen, but 75 percent paid by state money would not be significant enough for rapid development in Nenana Basin. MR. MERY said he is saying he is not sure. 2:28:32 PM CO-CHAIR SEATON asked whether a basin-opening credit of an additional percentage above the 65 percent would still stimulate folks to share the geological data with the state on a relatively short turn around for public access. MR. MERY qualified that he is speaking for Doyon only and said the quicker release is no trouble for Doyon because it has already shared a lot of data in the Nenana Basin way ahead of time with both the state and the public in an effort to get more investment and more aggressive investment. Regarding Doyon's Native lands in the Yukon Flats, he said the notion of sharing the data and making it public is an easy decision because that land is surrounded by federal lands that will never be opened to exploration; therefore, no competitive advantage would be lost by pushing data into the public sector sooner rather than later. 2:30:25 PM CO-CHAIR SEATON inquired whether Doyon finds it acceptable to be required to receive DNR's pre-approval to qualify for receiving the additional amount of credit. MR. MERY, again qualifying that he is speaking for Doyon only, stated that Doyon has a very good relationship with both the Division of Oil & Gas (DOG) and the Division of Geological & Geophysical Surveys (DGGS) and talks to them on a regular basis about its projects, so that is something that would not trouble Doyon at all. 2:31:30 PM CO-CHAIR SEATON observed that the DNR discussion document recommends a 50 percent payback provision for the additional basin-opening credit. He said he was not inclined to include such a provision because he thinks the amount of information and cooperation with the state would be well worth the additional 10 percent. He presumed that Doyon would not want to have the payback if it found something and asked whether Doyon believes it is more stimulating for getting investors if there is not a payback provision of the credit. MR. MERY replied, "Of course, yes." CO-CHAIR SEATON explained he wants to make sure that when this is approached at a future time it can be said it was discussed with the industry and the industry agreed that a payback provision on the 75 percent limit would be counter to the state's purpose of stimulating investors and drilling. He added that he thinks the committee is only talking about a limited number of wells per basin. 2:33:15 PM MR. BALASH, in response to Co-Chair Feige, pointed out that it would be the Department of Revenue administering this proposed program. REPRESENTATIVE HERRON asked whether the discussion document recommendations are set in stone. MR. BALASH answered that DNR was trying to capture the balance, relatively speaking, of something that might be available on a general basis. The legislature could limit the number of wells and go with a higher percentage, which is a policy call for the committee to make. However, he cautioned, under a more general law that opens multiple basins at a time, the higher the credit rate, the less of a natural selection there will be. There are parts of the state where it has been seen that free money engendered unrealistic hopes and expectations to go after things that are not there. REPRESENTATIVE HERRON said the discussion has evolved to whether the state should have a template and he does not believe the committee is interested in a template that says it is wide open and that would create a Wild West rush. The template is so that every single basin does not have to go through a meticulous legislative process, although there might be safeguards in the template that require DNR to come back for permission from the policy makers. 2:36:29 PM CO-CHAIR SEATON observed that some of the basins identified on the map may have development restrictions, such as Bristol Bay and the Aleutian Islands. He said he wants to ensure that there is nothing in the contemplation and offering of the credits in HB 276 that would override any places where leasing or exploration are off limits under current law. MR. BALASH quipped that if this could be done by offering a credit then perhaps the map could be moved a little farther north and east. CO-CHAIR SEATON understood Mr. Balash to be saying that having the credits in HB 276 would not change any lease restrictions that are currently in place MR. BALASH replied correct. He pointed out that even when state land is leased it does not entitle the lessee to explore however or where ever it wants. The lessee must still comply with all state requirements and permitting restrictions. Regarding the Aleutian Island basin identified on the map, he said that the area is largely representative of the Alaska Peninsula area-wide lease sale area where DNR has conducted an annual sale for the last 10 years and at one time had bidders and lessees. He said he thinks DNR might have one left there and that DNR still sees high potential in the region and continues to hold those lease sales. If a credit like this were available it might generate some additional interest that has not shown up at the last couple of sales. 2:39:32 PM CO-CHAIR FEIGE opened public testimony. LISA HERBERT, Executive Director, Greater Fairbanks Chamber of Commerce, stated that the chamber represents collectively 700 businesses in Interior Alaska. She offered the chamber's support for HB 276, speaking as follows: The Fairbanks Chamber has adopted a handful of key priorities this year that will ensure a healthy economic environment for both the business and residential communities of the Interior. Two of those priorities are to support initiatives that will reduce the high cost of energy and to also support projects and initiatives that will encourage new oil and gas development. We believe HB 276 is a step in the right direction in achieving both of these priorities for the Interior. As you know, we currently do not have access to affordable energy at this time. The small number of individuals and businesses who use natural gas for heat are paying three times as much as citizens in Southcentral Alaska. The cost of space heating and production of electricity is negatively impacting our economy's ability to grow. And many of our Interior families and businesses are struggling just to make due. This bill not only promotes exploration in the Interior, but it allows similar incentives to those offered in other regions of the state.... In addition, the seismic and technical data that will be collected in exploration is of benefit to the State of Alaska. We would like to commend Doyon, Limited, a large Interior corporation and Fairbanks Chamber member and other investors for their years of commitment to this particular region. Doyon and their partner investors have had a great success for showing potential in the Nenana Basin and surrounding areas and, as such, will offer the ability for oil and gas for local or regional use is extremely high. Additionally, the Fairbanks Chamber supports HB 276 because it supports short- to mid-term growth for Interior business communities. With the Nenana Basin's close proximity to Fairbanks, just 50 miles away, this legislation will help local businesses by affording them the opportunity to offer their products and services for the projects we hope will occur. These projects will also likely put Alaskan residents to work with new high paying and highly skilled jobs. 2:42:00 PM JERRY MCCUTCHEON stated that the original HB 276 was a good idea, but it has now been turned into garbage. He said Kotzebue should be addressed by itself because the solution for Kotzebue is probably different than for Nenana Basin. Nenana Basin deserves a clean bill that should have been passed half a dozen years ago. Kotzebue should receive grants or an appropriation to the Department of Natural Resources (DNR) to run the available two dimensional seismic through two dimensional enhanced seismic in time for the next session of the legislature. Regarding the Nenana Basin, he suggested that the operator be able to get back some share or multiple of investment early on and then, once the company gets its investment back, the state could "sock it to 'em". Mr. McCutcheon said that what he would like to see different is that the companies must first pay all their taxes due and then get their credits after justifying them. The state is doing it the wrong way by letting the companies determine what they want to take off and then the state playing a guessing game of what it is all about. He offered his hope that a bill for the Nenana Basin gets through the legislature this session. 2:45:09 PM REPRESENTATIVE STEVE THOMPSON, Alaska State Legislature, joint prime sponsor, said HB 276 was introduced in an effort to bring energy and home heating relief to Alaska's second largest community, which is only 50 miles from the Nenana Basin. The intent was to encourage investment and, hopefully, production of natural gas from that basin. The bill has grown quite a bit and he can understand the interest in wanting to help with additional frontier basins that are close to other regional areas in need of energy relief. He thanked the Department of Natural Resources, his staff, and the staff of other legislators who all put in an incredible amount of work researching how this might be accomplished. REPRESENTATIVE THOMPSON expressed his fear, however, that the weight of a growing fiscal note with more and more additions would sink the bill. He cautioned about taking existing credits of 65 percent and just adding 10 percent because 40 percent of the accumulated tax credits, which are in AS 43.55.025(b), sunset as of July 1, 2016, and the work would therefore have to be completed by that date. While he understood the need for energy in smaller areas other than the Fairbanks region, he said the intent was to keep it simple and get things accomplished. 2:47:19 PM CO-CHAIR SEATON appreciated Representative Thompson's concern and advised that the committee has amended a previous bill to extend those tax credits another 10 years, although that bill has not passed. He asked whether the sponsor would like to see the credits in AS 43.55.025(b) extended another 10 years if [Version M] goes forward. REPRESENTATIVE THOMPSON responded that that would definitely make it more acceptable and possibly more workable because if the bill's provisions did extend into other regions it would likely be past 2016 before anything could even start. CO-CHAIR FEIGE left public testimony open and held over HB 276.