CS FOR SPONSOR SUBSTITUTE FOR HOUSE BILL NO. 28(FIN) "An Act relating to adjustments to royalty reserved to the state to encourage otherwise uneconomic production of oil and gas; and providing for an effective date." This was the first hearing for this bill in the Senate Finance Committee. Co-Chair Wilken stated that this bill, "addresses oil and gas royalty modifications for marginal oil and gas fields. The new modification formula outlined in HB 28 allows the commissioner of Department of Natural Resources to negotiate a royalty rate that is in the best interest of the State." Senator Taylor offered a motion to report the bill from Committee with individual recommendations and accompanying fiscal note. Senator Taylor then objected to the motion for the purpose of taking testimony. Co-Chair Wilken ordered the motion out of order. REPRESENTATIVE VIC KOHRING, Sponsor, testified that in 1995 the legislature passed a law that provided for an oil royalty reduction. He relayed that the intent was to encourage development of marginal fields that are not profitable, including, new, existing and "mothballed" fields. He remarked that this statute "just hasn't worked" with the State receiving only one application for reduction that was not approved. He attributed the failure of the statute to its complexity and because it did not encourage industry participation. As a result, he sponsored the current legislation, which simplifies and streamlines the process. Representative Kohring explained this bill grants the commissioner of the Department of Natural Resources the authority to determine the level of reduction of royalty rates based on the economics of each field. He specified the reduction would be available for any marginal field or field that is not profitable in Alaska that could benefit from a royalty reduction. He noted the reduction would be applied on "a sliding scale basis", generally between three and 12.5 percent, based on the profitability of each field. He described the internal or contracted study that would be conducted to analyze fuel recovery, production rate and volume, and operating costs upon which the commission would base any decision whether to grant a reduction and at what percentage. Representative Kohring stressed the importance to provide incentive to develop marginal fields to generate income for the State. MARK MYERS, Director Division of Oil and Gas, Department of Natural Resources, testified that this bill would modify an existing royalty reduction statute, AS 38.05.180(j). He noted this statute had been previously amended, although some of the changes have proven cumbersome and unclear. He stated the existing statute is difficult to administer. Mr. Meyers stated this legislation would simplify the process yet still provide the commissioner "the necessary tools" to evaluate, condition and accept or reject an application for royalty reduction. He detailed the application and approval process for participation. He listed three cases for which a royalty reduction could be granted: a delineated field that a producer claims would be uneconomic to develop, an existing field that has proven to be uneconomic possibly due to declining production or increasing operating expenses, and fields that are "shut in already". He acknowledged that determination of whether a field is uneconomic is a complex process that also must factor the price of oil, cost of transportation, economics and size of the reservoir and size of the wells. Mr. Meyers pointed out that this legislation also allows a royalty structure that could "recapture dollars" if the economics of the field change. Mr. Myers assured that a royalty reduction would not be granted without extensive analysis of all relevant factors and an understanding of the reasonable rate of return on the project. Mr. Myers told of an application submitted by Unical, in which a reduction was offered although the company chose to not participate, and another application submitted by Conico, which the Department denied because it was not determined to be in the public interest. He stressed the applications are given serious consideration and that instances exist whereby a royalty reduction could result in a field beginning production or remaining in production. Mr. Myers cited current royalties are calculated at 12.5 to 16.66, and occasionally 20 percent. He recognized that a reduction to three percent would affect the economics of a field, although would not "materially change it in a very large scope." However, he emphasized the fiscal impact to the State is "very high". [Note: tape interruption] Co-Chair Wilken asked if this legislation allows for review. Mr. Myers replied that this bill includes a provision allowing for a legislative review of the preliminary best interest findings. He explained that the Legislative Budget and Audit Committee or "designated members" of the legislature to obtain the confidential data. Therefore, he assured that the legislature could choose to be directly involved in the process. He qualified that later reviews or changes would be subject to the terms of the contract between the producers and the State. He exampled a provision in contracts allowing for periodic economic review. KEVIN TABLER, Land and Government Affairs Manager, Unical, testified via teleconference from an offnet location in support of the legislation. He expressed that it would help clarify and provide flexibility for the commissioner to process a royalty application. He remarked that current statutes create an "unworkable situation". Senator Bunde commented he was encouraged by the testimony indicating that in the event of success, the State would have an opportunity to "recover on the upside". Senator Olson asked the number of wells and amount of revenues in question. Mr. Myers replied that the extent of this legislation would be highly variable and dependent upon companies' submission of applications. He knew of no pending applications. He noted some fields in the Cook Inlet are "late in their life of production" that would receive serious consideration if an application were submitted. He relayed that in review of other fields, it was estimated that the revenue amount "could easily be in the hundreds of millions of dollars" over the life of the field to "as much as a few tens of millions of dollars differential in the royalty rate." He qualified that the State could recover revenue if the contract were "conditioned properly". He stated that under the provisions of this legislation, a contract could be written to provide a net fiscal effect of nearly zero. He spoke to the need that "the tail be very long" and the royalty managed efficiently to recover revenue resulting from a royalty reduced from 12.5 percent to three percent. Senator Olson asked the outcome if the results are not as anticipated. Mr. Myers assured that a full technical analysis would be conducted to ensure the reduction is warranted. He listed geological and geophysical engineering, studies of the reservoir, production history and detailed cost data, as included in the analysis. He furthered that this legislation allows the State to engage a consultant to review the analysis. Mr. Meyers emphasized this legislation is a policy call. Senator Taylor offered a motion to report the bill from Committee with individual recommendations and accompanying fiscal note. There was no objection and CS SS HB 28 (FIN) MOVED from Committee with fiscal note #2 for $150,000.