SENATE BILL NO. 305 "An Act relating to the tax on oil and gas production; and providing for an effective date." Co-Chair Stedman introduced the bill. Co-Chair Hoffman MOVED to adopt CSSB 305 26-LS1577\S as a working document. Co-Chair Stedman OBJECTED for the purpose of discussion. 4:11:35 PM ROGER MARKS, LB&A CONSULTANT, LOGSDON AND ASSOCIATES, began the power point presentation, "SB 305: CS Version S & Amendments" (copy on file). He discussed Slide 2, "Version S Committee Substitute", which lists the recent changes in the language of the bill: · Title has tightened scope further · Technical changes in Section 5 ƒSome of the proposed changes to AS 43.55.020(a)(1) did not need to be there- CS reverses those changes. · Technical change- new Section 8 ƒGives authority to department to adopt regulations to allocate AS 43.55.170 adjustments to lease expenditures between oil and gas. Co-Chair Stedman requested further discussion on Section 8. Mr. Marks explained that in lease expenditures were discussed in AS 43.55.170. The accounting could be tricky and care should be taken that neither costs nor revenue was double counted. When discussing the split of oil and gas progressivity, it becomes necessary to define which lease expenditures apply to oil and which apply to gas. Section 8 gives the administration the authority to adopt regulations concerning how the lease expenditures should be divided. 4:15:39 PM Co-Chair Stedman REMOVED his OBJECTION to the CS. There being NO OBJECTION, the CS 26-LS1577\S was ADOPTED as a working document. 4:16:14 PM PAT GALVIN, COMMISSIONER, DEPARTMENT OF REVENUE, discussed the fiscal note. He stated that the method of acquiring and managing information from taxpayers would need to be changed prior to the decoupling of oil and gas, and funding was necessary in order to implement the changes. Currently, oil and gas production statewide is combined when determining the progressive tax rate. The potential change in state revenue was indeterminate. 4:18:37 PM Commissioner Galvin continued. The bill would affect current producers and the department had examined potential annual financial impact through the tax receipts. Refernced in the fiscal note was the range of tens of millions to hundreds of millions in a given year. The number fluctuates, which has added to uncertainty. 4:20:49 PM Co-Chair Stedman understood the numbers had been flexible. Commissioner Galvin agreed. He added that the potential impact was that more revenue could be expected when the price of gas and oil were divergent, and less than the status quo when prices were closer to the 10 to 1 ratio. Co-Chair Stedman requested that the fiscal note be rewritten due to changes made by the amendments. He referenced the language in the fiscal note. Commissioner Galvin said he would provide as many numbers as possible. Co-Chair Stedman said the committee would work with the department to craft a comprehensive fiscal note. Commissioner Galvin stated that the languase was not in reference to the expected market price. Co-Chair Stedman and Commissioner Galvin discussed the semantics of "normalcy" as it was written in the fiscal note. Co-Chair Stedman's maintained that the normalcy, under the price relationship between gas and oil, was a different normalcy than between the British Thermal Unit (BTU) equivalency. Co-Chair Stedman MOVED to adopt Amendment 1. Co-Chair Hoffman OBJECTED for the purpose of discussion. Mr. Marks continued to Slide 3, "Amendment 1: Tax Neutrality on Current Activity", which explains the intent of the amendment: · Currently some producers produce oil and gas. · If you separate oil & gas for calculating progressivity, progressivity on oil will be undiluted by gas and taxes will increase. · It is not intent of bill to raise taxes on current oil and gas activity · Amendment 1 ƒCredit equal to difference between tax determined under bill and tax determined now ƒCredit expires in 2015 4:26:45 PM Co-Chair Stedman noted that the credit would expire in 2015. Mr. Marks explained that the 2015 expiration date would protect the state from a collapse in oil revenue if an AGIA plan is implemented, without causing taxes on current activity. Hopefully discussions on a tax regime for gas will have occurred by the 2015 date. Senator Thomas inquired about Cook Inlet gas production. Mr. Marks responded that there were sets of producers that had North Slope oil and Cook Inlet gas. Those producers, based on current activity, would see tax increases without the amendment. Co-Chair Stedman REMOVED his OBJECTION to Amendment 1. There being no further OBJECTION the amendment was ADOPTED. Co-Chair Hoffman MOVED Amendment 2. Co-Chair Stedman OBJETED for the purpose of discussion. 4:30:52 PM Mr. Marks continued his presentation. He explained that Prudhoe Bay was producing 270,000 barrels of oil per day. Oil cannot be removed from the earth without the accompaniment of natural gas. The gas is separated and some is placed back in the ground to re-pressurize the field for oil production. If in the future the gas is also marketed, Prudhoe Bay would become an oil and natural gas field, which most fields are. The costs to produce oil and gas are joint, which makes it necessary to allocate costs between oil and gas in order to tax them separately. Slide 5, "Amendment 2: Cost Allocation", details the changes made by amendment 2, and are as follows: · Retain current agency authority, and · Consider BOE approach · Costs to produce oil and gas are truly joint costs: the same process that produces one produces the other · Benefit of current approach (AS 43.55.165(h)) that gives department authority to adopt regulations for allocation costs between oil and gas: ƒAs recipient of confidential cost data they are in the best position to evaluate costs ƒA regulatory process allows more time ƒThe regulator process is public Mr. Marks explained the BTU Equivalent Barrel (BOE) Approach. He stated that it was the same approach that was currently embraced in the departmental regulations. The mechanics (AS 43.55.900(3)) read: 1 barrel of oil= 1 BOE 6 mmbtu's to the barrel Gas mmbtu's/6= gas BOE's Mr. Marks said that the rationale for the BOE approach is that the same costs that produce oil also produce gas. The BOE method puts oil and gas on an "apples to apples" basis in terms of relative produced volumes. 4:34:50 PM Mr. Marks continued. Slide 7, "Problems with other Methods", which details the different approaches that could be taken to allocate costs. He discussed the various approaches and the scenarios that could come into play: · Item by item attribute ƒInappropriate where costs are truly joint · Dominant use (either all oil or all gas) ƒInappropriate when large volumes of both are produced · Deemed approach (deemed one unless item id 100 percent the other ƒInappropriate when large volumes of both produced · Reserves ƒUncertain numbers/subject to taxpayer control · Gross value ƒUpstream costs should not change with downstream prices 4:36:55 PM Mr. Marks continued to Slide 8, "A Note on 15 AAC 55.220": · Department of Revenue's proposed regulation on AGIA uses the Gross value approach to allocate the total tax between oil and gas · Allocation tax is different than allocating costs · Gross value is a very material determinant of the differences in tax value between oil and gas · Allocating tax by gross value for this purpose is reasonable Mr. Marks addressed the concern for the treatment of Point Thomson. Slide 9, "A Note on Allocation of Capital Costs Associated with Developing Pt. Thomson", reads: · High development costs will be incurred prior to gas sales: these costs will allocated against oil · Pt. Thomson is also an oil (condensate) field (est.300 million barrels) · Could be developed such that it produces condensate years before it produces gas · PPT/ACES were deliberately designed so that cost deductions and credits would be utilized immediately 4:41:59 PM Mr. Marks reiterated that the amendment allows the department to maintain authority for the allocation of lease expenditures. Co-Chair Stedman removed his OBJECTION to the amendment. There being NO OBJECTION, Amendment 2 was ADOPTED. Commissioner Galvin expressed appreciation for the language in Amendment 2. The desire of the department would be to put the language into statute in order to avoid problems in the regulatory process. 4:45:55 PM Co-Chair Stedman stated that the committee was determined to work with the department on the language pertaining to cost allocation. He asserted that this was not the main reason that the bill was on the table but hoped that significant conversation on the issue would be had before 2015. Commissioner Galvin replied that if the allocation was to be based on current or projected costs, there were significant costs that would be joint costs in production. He felt other considerations would need to be examined. He assured the committee that the department would continue to work with the committee, but felt that further guidance would be necessary. 4:48:12 PM Co-Chair Stedman said that a solution was necessary. He requested that the department provide records from the last three years on the impact of the dilution, dealing with Cook Inlet and the North Slope, to educate the committee on the numbers. Commissioner Galvin said that Amendment 1 makes the fiscal note moot. Co-Chair Stedman said that a new fiscal note would be needed to ensure that the public has the opportunity to see the language and the fiscal impact. 4:50:09 PM