HB 81-OIL/GAS LEASE:DNR MODIFY NET PROFIT SHARE  2:15:36 PM CHAIR PATKOTAK announced that the final order of business would be HOUSE BILL NO. 81, "An Act authorizing the commissioner of natural resources to modify a net profit share lease." [Before the committee was CSHB 81(RES).] CHAIR PATKOTAK noted that Legislative Legal Services requested the committee substitute to conform the bill to legislative drafting style. 2:16:14 PM REPRESENTATIVE HOPKINS moved to adopt the proposed committee substitute (CS) for HB 81, Version 32-GH1706\B, Nauman, 3/16/21, as the working document. There being no objections, Version B was before the committee. 2:16:33 PM CHAIR PATKOTAK moved to adopt Amendment 1 to Version B, labeled 32-GH1706\B.2, Nauman, 3/16/21, which read as follows: Page 2, lines 17 - 18: Delete "for which additional capital expenditures  would make future production no longer" Insert "from which, without additional capital  expenditures, future production would no longer be" 2:16:51 PM REPRESENTATIVE HOPKINS objected for purposes of discussion. 2:17:15 PM EMILY NAUMAN, Deputy Director, Legislative Legal Services, Legislative Affairs Agency, explained that in the process of creating the committee substitute she discovered an error in drafting the bill, which is corrected by Amendment 1. In response to Representative Fields, she clarified that in the original bill, the wording did not conform with the intent of the bill, so the amendment clarifies [in Version B] that "without additional capital expenditures, future production would no longer be" economically feasible. REPRESENTATIVE FIELDS asked whether, with the new language, there is a concern that a company might ask for more favorable lease treatment in lieu of capital expenditures. He noted that in general it would be preferable to have more investment rather than changing the lease terms. MS. NAUMAN replied that the purpose of this amendment was to clarify what she believed to be the original intent of the bill. REPRESENTATIVE FIELDS said that perhaps the Department of Natural Resources (DNR) could address its process for ensuring additional investment rather than more favorable treatment from the state for an existing production area. 2:22:36 PM JHONNY MEZA, Commercial Section Manager, Division of Oil and Gas, Department of Natural Resources, clarified that it is not the intent of DNR to provide assistance in the form of a modified net profit share lease in cases where capital expenditures would otherwise be required to ensure future economic feasibility. 2:24:01 PM REPRESENTATIVE FIELDS asked whether there exist statutes or regulations that provide the DNR with direction to take that stance. MR. MEZA responded, "The statute mandates that the DNR commissioner maximizes the value of the oil and gas resources to the people of Alaska, and ... any modification of royalty or net profit share that could be contemplated would follow that goal." REPRESENTATIVE FIELDS asked whether it would be better to delete "additional capital expenditures" [from page 2, line 17, of Version B], so that the bill doesn't unintentionally disincentivize capital investment. 2:25:20 PM REPRESENTATIVE SCHRAGE offered his belief the Amendment 1 would do the opposite of what the proposed legislation intended by allowing the modification of a net profit share agreement. 2:26:26 PM MR. MEZA replied as follows: Our intent is to encourage that this proposed capital expenditures be incurred by the lessee such that future production can come online. When they perform their economic evaluation, they may find that such an endeavor is not profitable enough to motivate them to sanction that investment. If by modifying the royalty rates or the net profit share, sanctioning that investment is considered as a profitable endeavor by the lessee, which includes their capital expenditure, then that's ... the goal that we're trying to accomplish. So, in other sense, in a given project we're not trying to modify the amount of capital expenditures that a lessee may be contemplating by modifying the royalty or net profit share, with the proposed capital expenditures, we're trying to encourage such future production to become economic. 2:27:35 PM REPRESENTATIVE SCHRAGE said: So, what I just heard is that ... if there is analysis done that shows additional capital expenditure would make future production economically feasible, they would be denied the adjustment to the net profit sharing agreement. And so I do believe the text in the bill, as currently written in version B, is correct. RPRESENTATIVE SCHRAGE then noted that it could be put into simpler language, but that he believes "it matches the intent of the bill. 2:28:16 PM CHAIR PATKOTAK noted that this is DNR's bill, and the intention of the department was to give the DNR commissioner the authority to modify net profit share lease agreements. 2:28:55 PM RYAN FITZPATRICK, Commercial Analyst, Division of Oil and Gas, Department of Natural Resources, said that Legislative Legal Services brought the matter of the language to the attention of the department, and that both agencies agree that the language in the amendment achieves the intent of the bill. He referred to [subparagraph] (D), on page 2 of Version B, and said that with the new language inserted it would read: "to prolong the  economic life of an oil or gas field or pool for which  additional capital expenditures would make future production no  longer economically feasible". He said that this language is to make it clear that in order to be eligible for a royalty or net profit share modification, the lessee would have to make additional capital expenditures. He reemphasized that the royalty or net profit share modification would hinge on the lessee making the capital expenditure. 2:30:59 PM REPRESENTATIVE FIELDS directed his remarks to Ms. Nauman and said that the plain language of [HB 81, Version B] seems to give DNR the ability to adjust lease terms in the absence of capital expenditures. He asked whether there's a way to clarify in stronger terms that capital expenditures and the economic benefits that accompany them are preferable, and that adjusting the lease terms is a "last resort" decision. 2:31:45 PM MS. NAUMAN responded that she agrees that the language wouldn't necessarily require a lessee to make capital expenditures; instead, it would require the department to make a finding that without additional capital expenditures, future production wouldn't be economically feasible. 2:32:32 PM REPRESENTATIVE FIELDS said that he understands that the purpose of the proposed legislation is to prolong production and that he believes the committee should pursue language making it clear that changing the lease terms is a last-resort decision. 2:32:58 PM The committee took an at-ease from 2:33 p.m. to 2:35 p.m. 2:35:30 PM REPRESENTATIVE SCHRAGE said that there are two scenarios in which the net profit share lease would be adjusted. One is a case in which there is no production on the lease, so it would be preferable for the company to make the investment in capital; if an investment would not make economic sense for the company, then the lease agreement could be adjusted to incentivize production. The second scenario, he said, would be a case in which there is production occurring on a lease but it's toward the end of its useful life, and that life could be extended by adjusting the net profit share agreement to incentivize further capital investment to extend the life of the lease. In either case, he said, there would exist a capital investment. He said that he would like to explore clarifying the language to refine the amendment. MR. MEZA said that Representative Schrage's remarks accurately described the conditions for royalty under the statute. He summed up the possible scenarios as A) for new production, and B) existing production which may be near abandonment and need capital expenditures. He then added two additional scenarios: C) to restore production that had already been shuttered, and a newly-proposed scenario D) for incremental production, which looks similar to scenario B but differs in that the operation doesn't necessarily require additional capital expenditures for future production. 2:38:44 PM REPRESENTATIVE FIELDS said that he would prefer to get Ms. Nauman's input clarifying that this bill is for application to cases in which the adjustment of lease terms is necessary for production to continue, as opposed to allowing lessees to abdicate their responsibility to make capital investments in order to keep producing. 2:39:20 PM REPRESENTATIVE SCHRAGE asked whether it is the intent of the DNR to be able to adjust a net profit share agreement without any capital investment taking place, simply to extend the duration of production on that field. MR. MEZA said that there is one existing scenario for royalty modification, scenario B as previously described, which contemplates prolonging the economic life of an oil or gas field or pool where continuation of production could, by necessity, require capital expenditure; in scenario D, however, it is not a requirement. 2:41:01 PM REPRESENTATIVE MCKAY said that it costs money just to produce the field without any additional capital investment; he said that there is one scenario in which the lessee may shutter the well unless more profit is possible in the future. He said that's the condition in scenario B. 2:42:08 PM REPRESENTATIVE HOPKINS noted that Mr. Meza had described the condition of being "not profitable enough" and said that Mr. Meza said that the net profit share lease rate could be lowered if the field or pool was "not profitable enough." He asked whether the intent of this bill is to make a pool or field more profitable, or simply to make it profitable at all. MR. MEZA answered that the goal for the lease modifications is to increase the likelihood that a project will be economically advantageous and to motivate the investment decision by the lessee. He said DNR cannot guarantee profitability of a project, and that this bill is to increase the likelihood that an investment in capital expenditure will take place. REPRESENTATIVE HOPKINS asked whether a change in the net profit share rate could be made with no guarantee that capital investments would be made in the future. MR. MEZA answered that is correct with respect to all of the cases with petitions for modification. He noted an earlier presentation in which he described a 2014 decision made to modify the royalty agreement; the project did not come to fruition despite granting the royalty modification. 2:44:26 PM CHAIR PATKOTAK acknowledged that there is opportunity for DNR and Legislative Legal Services to work with the offices to clarify Amendment 1. [Amendment 1 was tabled, with the motion to adopt left pending.] 2:46:13 PM The committee took a brief at-ease. 2:47:03 PM REPRESENTATIVE HANNAN moved to adopt Amendment 2 to Version B, labeled 32-GH1706\B.1, Nauman, 3/15/21, which read as follows: Page 2, line 18, following "feasible;": Insert "a royalty modification may not be made  under this subparagraph;" Page 2, line 30: Delete "or (1)(D)" Page 4, line 5: Delete "or net profit share" Following "(1)(A)": Insert "of this subsection or a net profit share  reduction under (1)(A)" 2:47:07 PM [REPRESENTATIVE RAUSCHER objected for discussion purposes.] 2:47:13 PM REPRESENTATIVE HANNAN said that the Amendment 2 focuses on [subparagraph] (D) and that Version B, as presented, focuses only on net profit share agreements, of which there are 26; royalty agreements, of which there are thousands, can already be modified in accordance with the DNR commissioner. If this bill passes with subparagraph (D) as currently written, she said, both net profit share and royalty agreements could be modified based on capital expenditures. She believes, she said, that investment to keep up production is standard in the industry, and that capital investment is necessary as a field ages. She said that the goal of the bill is to get the 26 existing net profit share agreements, most of which have not been in production, into production; therefore, Amendment 2 says that a producer must incur capital investment in order to modify the terms of a net profit share lease. She said that she wants to make subparagraph (D) exclusive to the net profit share agreements. 2:51:12 PM CHAIR PATKOTAK noted that based on the presentation in the committee meetings the focus of the proposed legislation is on changing the commissioner's authority regarding the net profit share leases, not the royalty leases. MR. MEZA confirmed that it is correct that there are 26 net profit sharing leases on the North Slope, spread out among many productive oil and gas units. Many of the leases themselves are still producing, which is the reason for including subparagraph (D) - allowing modifications for leases on sites in order to prolong the economic life in the absence of capital expenditures, which would make future production economically unfeasible. They are including this scenario, he said, inclusive of royalty-only leases of net profit share leases. 2:53:05 PM REPRESENTATIVE HOPKINS noted the title of the bill, "An Act  authorizing the commissioner of natural resources to modify a  net profit share lease."  He asked whether the intent of this bill is to allow a royalty-only lease to change into a net profit share lease, or to change only the net profit share rate on a net profit share lease. 2:53:37 PM MR. MEZA said that the intent is for the DNR commissioner to have the authority to modify either the royalty rate or net profit share rate; the current statute, he said, already allows the commissioner to modify royalty rates for any type of lease, but this bill is proposing giving the commissioner the authority to modify the net profit share rate. He said that the newly- proposed scenario under subparagraph (D) is for a scenario that would apply to both net profit share modification and royalty modification, as would the three existing scenarios A, B, and C. [These scenarios were previously described in a PowerPoint presentation given by Mr. Meza during the House Resources Standing Committee meeting on March 5, 2021, and they paraphrase the provisions under subparagraphs (A), (B), and (C), and the proposed subparagraph (D).] REPRESENTATIVE HOPKINS said that Mr. Meza's notes clarified the intent. 2:55:10 PM CHAIR PATKOTAK said that as he understands it, in order to change the net profit sharing lease's royalty agreement, the lessee would have to meet the requirements in scenarios A, B, and C, and he asked if that is correct. MR. MEZA replied that, yes, that is correct; the scenarios A, B, C, and the newly-proposed scenario D are the scenarios for eligibility. A lessee applying for modification of royalty or net profit share would be required to demonstrate that the project would meet the criteria A through C, as well as the newly-proposed scenario D, and provide the technical and financial data that would demonstrate future production in order to modify either the royalty and/or net profit share rate. 2:56:21 PM REPRESENTATIVE HOPKINS asked whether it is the intent of DNR to allow a change to the rate on a royalty-only lease, adhering to subparagraph (D); he offered his understanding that doing so would be outside the scope of the proposed legislation based on its title. MR. MEZA said that under subparagraph (D), it is possible to have a modification to a royalty-only lease and that the intent of DNR is to include leases that only have a royalty component. The reason for this, he stated, is that the fields or pools which are currently producing but may be nearing the end of their economic life may need a modification of net profit share or royalty rates in order to maximize production, as well as revenue to the state. 2:58:31 PM CHAIR PATKOTAK said he understands that if there exists a royalty-only lease that is ending its life, then perhaps there should be a modification to the royalty agreement and inclusion of a net profit share lease, adding to the total number of net profit share leases overall, depending on the situation. [The motion to adopt Amendment 2 was left pending.] CHAIR PATKOTAK announced that HB 81 would be held over.