SENATE BILL NO. 309 "An Act amending and extending the exploration and development incentive tax credit under the Alaska Net Income Tax Act for operators and working interest owners directly engaged in the exploration for and development of gas from a lease or property in the state; providing for an effective date by amending the effective date for sec. 2, ch. 61, SLA 2003; and providing for an effective date." Co-Chair Stedman noted this was the first hearing of the bill. He said that amendments would be allowed today. 9:12:12 AM SENATOR LESIL MCGUIRE, SPONSOR, explained that SB 309 has become an amalgamation of a variety of bills designed to incentivize oil and gas exploration efforts, both in Cook Inlet and in Prudhoe Bay. The first part of the bill deals with Southcentral Alaska which is suffering from a decline in drilling and exploration activities in the Cook Inlet area. Research indicates that by 2013, at the current drilling rate, there is a very real possibility that Liquid Natural Gas would need to be imported from Indonesia. The goal is to increase drilling activity in the area, which is unique and has many challenges. Senator McGuire addressed the first part of the bill. During the interim, time was spent talking with Cook Inlet explorers in an attempt to develop incentives. The bill amends and extends the exploration and development incentive tax credits that were originally enacted in 2003 under the Alaska Net Income Tax Act. The current bill, SB 309 changes the 10 percent amount to 25 percent of a credit against state income tax liability. The 50 percent limitation on the amount of credits allowed to be taken in a single year was eliminated in SB 309. Now, 100 percent of all qualified credits for exploration and development can be taken in a single year. 9:14:35 AM Senator McGuire explained that the second part of the bill would extend the sunset date of the investment tax credit from January 1, 2013, to January 1, 2020, allowing the companies to make longer-term business decisions. Senator McGuire related that another part of the bill addresses infield drilling vs. new pockets of drilling in Prudhoe Bay. The bill would allow infield drilling to occur and credits taken for that, as well. Co-Chair Stedman asked for an explanation of infield drilling. Senator McGuire explained that under the original legislation, drilling had to be done outside of an existing well. Infield drilling is done near an existing, proven well reserve. Previously, high risk areas were incentivized; however, this bill allows for infield drilling, as well. The state is willing to take a risk to move into higher risk activities. 9:17:03 AM Senator McGuire highlighted the second part of the bill called the "Stampeder Provision", provisions added by Senator Wagner. The main idea is to bring a jack-up rig (Section 11) into Cook Inlet. The provision would provide credits for the first, second, and third drillings. It would mean a state investment of between $24 million to $54 million. She termed it high risk activity. Senator McGuire informed the committee about the fixes to Alaska's Clear and Equitable Share (ACES) production tax included in the bill. Small companies are asking for a reduction in the progressivity rate, the allowance of capital credits to be taken in one year, and the ability to access the oil and gas tax credit fund. Senator McGuire pointed out that there are more companies using the tax credits than originally was envisioned. Senator McGuire stated support for the two proposed amendments. 9:20:13 AM MIKE PAWLOWSKI, STAFF, SENATOR LESIL MCGUIRE, reported on the sectional analysis: Section 1 amends AS 43.20.043 (a) by increasing the gas exploration and development tax credit to 25% on qualifies capital expenditures and annual costs from 10% for investments made after December 31, 2009. Section 2 amends AS 43.20.043 (b) to conform to the changes made in section 1. 9:21:14 AM Section 3 amends AS 43.20.043 (c) to repeal the 50% cap on the application of the gas exploration and development tax credit against the Alaska Net Income Tax. Co-Chair Stedman asked for clarification of the tax liability. Mr. Pawlowski said it was the corporate income tax liability. Section 4 amends AS 43.20.043 (e) to ensure that the value of a credit under AS 43.20.043 is passed through to consumers in a rate base submitted to a regulatory agency. Section 5 amends AS 43.20.043 (g) to clarify that if a taxpayer elects to take a credit under AS 43.20.043 the taxpayer may not also claim a tax credit or royalty modification under other identified sections of Alaska law. Section 6 amends AS 43.20.043 (i)(1) to allow a taxpayer to claim a credit under AS 43.20.043 for development in an existing field and for an expenditure that does not lead to production. Section 6 also clarifies that topping plants, treatment or liquefied natural gas and other manufacturing plants are not qualified expenditures. 9:23:46 AM Section 7 amends AS 43.20.043 to clarify that a credit under AS 43.20.043 may be taken in the year in which the expenditure is made or cost is accrued, or in the following tax year. Section 8 amends AS 43.55.023 (a) to allow a tax credit taken against a capital investment under ACES to be realized in the year in which the credit is accrued. Co-Chair Stedman asked if the credit applies statewide or just to Cook Inlet. Mr. Pawlowski said it applied statewide under ACES. All previous sections apply to Cook Inlet. Section 9 amends AS 43.55.023 (d) to conform to the change in section 8. Section 10 amends AS 43.55.025 (a) to create a special tiered exploration tax credit of 80, 90 or 100 percent of total exploration expenditures. Section 11 amends AS 43.55.025 by adding a new subsection (m) to clarify that the special credit established in section 10 is for the first three unaffiliated wells drilled into the pre-Tertiary strata in Cook Inlet using a jack-up drill rig. Also caps credits; lesser of 100% credit or $25 million, lesser of 90% credit or $22.5 million; lesser of 80% credit or $20.0 million. Only one credit per person, may not include cost to construct or manufacture a jack-up rig and must be for work performed after June 30, 2010. If exploration results in sustained production of oil or gas, 50 percent of credit received shall be repaid. Taxpayer obtaining credit in this section may not claim credit under AS 43.55.023 or another provision in this section for the same exploration expenditure. Provides definitions for "jack-up rig", "reservoir" and "sustained production". 9:26:37 AM Mr. Pawlowski explained that Section 12 is language that extends the sunset date. Section 13 amends the uncodified law related to the carry forward of credits accrued under AS 43.20.043 beyond the sunset date of the credit. Section 14 repeals AS 43.55.028 (e) (2) and (e) (3) which requires a small producer accessing the oil and gas tax credit fund to make additional expenditures within 24 months of claiming the credit. Section 15 extends the sunset of the tax credit under AS 43.20.043 to 2020 from 2013. Section 16 adds an immediate effective date. 9:28:18 AM Co-Chair Stedman asked for a definition of jack-up rig and the stampede concept. SENATOR THOMAS WAGONER, SPONSOR, related the history of units in Cook Inlet which have made it more appealing to use jack-up rigs. He stated that almost every place drilled contains gas. He recalled that during the Murkowski era the use of jack-up rigs was proposed to incentivize Cook Inlet. This bill allows for the drilling of three wells off shore using jack-up rigs. Senator Wagoner explained that a jack-up rig is used for drilling in shallow or deep water. Of the three wells listed in the bill, the first would be incentivized at 100 percent of drilling costs up to $25 million, the second well would be at 90 percent up to $22.5 million, and the third well would be at 80 percent up to $20 million. If a company hits a commercially sized deposit, then once it goes into production, over the next 10 years, the state would receive 50 percent of the credits back. He predicted that the state would make money from this provision. 9:33:01 AM Senator Wagoner related that there are currently two or three small independent companies set to take advantage of the provision. Co-Chair Stedman asked if one entity could qualify for all three incentives. Senator Wagoner said it had to be three different companies with three different wells. In addition, going below the pre-Tertiary level should give the state new, valuable geological information. 9:34:40 AM Senator Thomas asked if the tax credits are consistent throughout the bill. Senator Wagoner replied that under the stampede provision information is available to the state. Senator McGuire clarified that as the bill sits now, there is no requirement of disclosure of broader provisions to DNR, such as income tax relief. The companies reported that they would not take the credit if forced to share that data. If the income tax relief is taken, the company does not qualify for other exploration and development credits which are much more valuable. Companies are required to provide data, except for when it is related to income tax relief. Senator Wagoner added that there are "corner shooters". If drilling data is made available, competing companies would take advantage of the proximity to wells on land leases with corners. Senator Thomas thought that a data-collecting aspect could be added later. 9:38:38 AM Co-Chair Stedman requested that Commissioner Galvin explain the bill's components. PAT GALVIN, COMMISSIONER, DEPARTMENT OF REVENUE, suggested the bill be broken down into three segments. The first segment would be targeted credits for gas exploration everywhere south of the North Slope. This section of the bill provides an alternative to using production tax credits in the form of a corporate income tax credit - 25 percent of expenditures for gas exploration. It also enhances an existing program by increasing it from 10 percent to 25 percent. Commissioner Galvin explained that the second area deals with jack-up rigs, an area DNR has focused on for years. There is an economic hurtle to overcome to get these in place. He opined that they would be used by many companies. The bill provides for a creative way to attract companies to explore and drill new wells. Commissioner Galvin related that the third category enhances the overall production tax system; capital credits allowed the first year and the elimination of the requirement to make additional investments in order to qualify for a state purchase of capital credit certificates. Existing companies take advantage of these companies; however, new companies don't know if they qualify for full value. The bill eliminates a barrier and allows companies to purchase certificates. 9:43:50 AM Co-Chair Stedman recalled past dialogue about splitting credits or postponing them. He requested information about why the credits are allowed to be taken in one year. Commissioner Galvin explained the reasoning behind that provision. It would enhance the value of the credits. It would be an economic driver for the companies and not have a large impact on the state. From an administrative viewpoint, it is less cumbersome to give the credit at one time. Co-Chair Stedman asked if that reason overrides the issue of predictability to the state. Commissioner Galvin appreciated the question. He said that during the 50/50 discussion there was merit to spreading the credits over two years. It was discovered that the information-sharing part has proven to be more valuable. Co-Chair Stedman asked about the timing of the change to one year. Commissioner Galvin explained that the bill is currently written so that the changes take effect immediately, which is problematic. He thought an amendment would clean up the effective date and make the two provisions retroactive to January 1, 2010. 9:48:01 AM Co-Chair Stedman noted two fiscal notes, one zero fiscal note from the Department of Natural Resources, and one indeterminate fiscal note from the Department of Revenue. Senator Huggins MOVED to ADOPT New Amendment 1: Page 1, line 4, following "in the state;": Insert "relating to interest on certain underpayments or overpayments for the oil and gas production tax;" Page 1, line 7, following "basin;": Insert "relating to the use of the oil and gas tax credit fund to purchase certain tax credit certificates;" Page 5, following line 21, insert a new section that reads: *Sec. 8. AS 43.55.020 is amended by adding a new subsection to read: (i) Notwithstanding any contrary provision of AS 43.05.225 or (g) or (h) of this section, if the amount of a tax payment, including an installment payment, due under (a)(1) - (4) of this section is affected by the retroactive application of a regulation adopted under this chapter, the department shall determine whether the retroactive application of the regulation caused an underpayment or an overpayment of the amount due and adjust the interest due on the affected payment as follows: (1)if an underpayment of the amount due occurred, the department shall waive interest that would otherwise accrue for the underpayment before the first day of the second month following the month in which the regulation became effective, if (A) the department determines that the producer's underpayment resulted because the regulation was not in effect when the payment was due; and (B) the producer demonstrates that it made a good faith estimate of its tax obligation in light of the regulations then in effect when the payment was due and paid the estimate tax; (2)if an overpayment of the amount due occurred and the department determines that the producer's overpayment resulted because the regulation was not in effect when the payment was due, the obligation for a refund for the overpayment does not begin to accrue interest earlier than the following, as applicable: (A)except as otherwise provided under (B) of this paragraph, the first day of the second month following the month in which the regulation became effective; (B)90 days after an amended statement under AS 43.55.030(a) and an application to request a refund of production tax paid is filed, if the overpayment was for a period for which an amended statement under AS 43.55.030(a) was required to be filed before the regulation became effective. Renumber accordingly. Page 9, following line 11, insert new sections that read: *Sec. 15. The uncodified law of the State of Alaska is amended by adding a new section to read: TRANSITION: APPLICABILITY OF SEC. 8 OF THIS ACT. Section 8 of this Act applies to taxes, including installment payments of estimated tax, due on or after January 1, 2006. *Sec. 16. The uncodified law of the State of Alaska is amended by adding a new section to read: RETROACTIVITY OF SECS. 8-10 OF THIS ACT. (a) Section 8 of this Act is retroactive to January 1, 2006. (b) Sections 9 and 10 of this Act are retroactive to January 1, 2010. *Sec. 17. The uncodified law of the State of Alaska is amended by adding a new section to read: RETROACTIVITY OF REGULATIONS. Notwithstanding any contrary provision of AS 44.62.240, if the Department of Revenue expressly designates in the regulation that the regulation applies retroactively to a specific date, a regulation adopted by the Department of Revenue to implement, interpret, make specific, or otherwise carry out secs. 8, 9, or 10 of this Act applies retroactively to that date. *Sec. 18. Section 13 of this Act takes effect July 1, 2010. Renumber accordingly. Page 9, line 12, following "Sec. 15.": Delete "This" Insert "Except as provided in sec. 18 of this Act, this" Renumber accordingly Co-Chair Stedman OBJECTED. Senator Huggins stated that the amendment represents fair play and prevents unintended consequences from both overpayment and underpayment scenarios from the taxpayers. Commissioner Galvin explained that the amendment is designed to clarify that when there are regulations requiring retroactivity, the tax penalty would not acquire interest on the underpayment. The department currently has discretion to waive penalties, but not interest. Co-Chair Stedman asked for a synopsis of the interest rate. Commissioner Galvin explained that the interest rate is a formula; the higher of either 11 percent or 5 percent above the treasury rate. Co-Chair Stedman asked how often it is compounded. Commissioner Galvin said quarterly. Co-Chair Stedman informed the public about a concern the amendment addresses. 9:51:58 AM Commissioner Galvin referred to the bottom of page 2 and onto page 3, which clarifies the effective dates of the various sections of the bill. Co-Chair Stedman WITHDREW his OBJECTION. There being NO OBJECTION, it was so ordered. Senator Thomas WITHDREW Amendment 2. AT-EASE 9:52:53 AM RECONVENED 9:54:10 AM Co-Chair Stedman turned to the public testimony portion of the hearing. 9:54:41 AM CARRI LOCKHART, MARATHON OIL, (via teleconference), testified in support of the legislation. She commented about the need for on-going, long-term exploration in Cook Inlet. She spoke about uncertainties in the market. She stressed that in order to qualify for the investment tax credit, Marathon Oil has to make capital investments, which will add some value back to the state. 9:58:13 AM Senator Wagoner stated that the bill was good for Alaska. SB 309 was heard and HELD in Committee for further consideration. AT-EASE 9:59:18 AM RECONVENED 10:00:08 AM Co-Chair Hoffman brought the meeting back to order. He noted it was the first hearing of HB 365; however, the companion bill, SB 255, was heard on April 9.