SENATE BILL NO. 192 "An Act relating to the oil and gas production tax; and providing for an effective date." 1:03:23 PM SENATOR JOE PASKVAN, began on slide 60 of a PowerPoint presentation [also heard during the March 13, 2012 morning meeting] titled "Committee Substitute for Senate Bill 192 (RES) Oil and Gas Production Tax Rates" (copy on file). He referred to a hearing before the Committee on Energy and Natural Resources, United States Senate, New Developments in Upstream Oil and Gas Technologies: Testimony by Kevin Banks, Director, Division of Oil and Gas, Alaska Department of Natural Resources (May 10, 2011). He explained that Mr. Banks had spoken about potential for production and throughput through the Trans-Alaska Pipeline System (TAPS) including heavy and shale oil. He quoted from Mr. Banks' testimony: There are no known conventional resources on State or Native lands that are likely sufficient to replace the decline in the existing production rates. Senator Paskvan believed that although the state should remain optimistic about heavy and shale oil and Outer Continental Shelf resources, the information from Mr. Banks was poignant. He moved to slide 61 titled "TAPS Throughput Continues Steady Decline" that included testimony from a March 1, 2012 Senate Resources Committee meeting. He had asked Scott Jepsen, Vice President, External Affairs, ConocoPhillips Alaska whether Alaskans should expect to see 1 million barrels a day from state lands in conventional oil with the $5 billion investment over the next ten years. Mr. Jepsen had remarked previously that the expenditure of the $5 billion would commence in the upcoming three years, but would be spent over the next six to ten years. Mr. Jepsen had indicated that 1 million barrels a day was a good aspirational goal, but he didn't think it was possible to get there with conventional oil. Mr. Jepsen hoped that other types of technologies may increase throughput from shale or heavy oil. 1:06:52 PM Senator Paskvan addressed slide 62 "Other Oil Producing Regions Enjoying Production and Employment Booms" and the resurging North American oil production issues. He referenced how technology had created an upheaval in the North American natural gas markets. The slide highlighted the transfer of technology that had transformed the natural gas field and its promise to improve oil production in the United States. The technology had caused the surge in natural gas production, which was transforming the outlook for oil production in America. He quoted material from the slide (source: Citi Investment Research & Analysis, February 15, 2012): Advances in the use of horizontal drilling and hydraulic fracturing have unlocked vast reserves of hydrocarbons originally trapped in highly dense shale rocks. The two shale oil plays that have benefited most from this transformation so far are the Bakken and Eagle Ford. Senator Paskvan noted that Bakken was located in North Dakota and that Eagle Ford was in Texas. He hoped that the shale and heavy oils would arrive in and benefit Alaska in the near future. He asked his staff to walk through the subsequent slides related to rig counts. JEFF, STEPP, STAFF, SENATOR JOE PASKVAN, referenced a comment by Senator Paskvan that Alaskans expected policy makers to act like "sophisticated owners of a world-class resource." He stated that part of being a sophisticated owner was performing a sophisticated analysis of the relevant issues. He pointed to comparisons made between Alaska, North Dakota, and Texas. He quoted from slide 62: The unrelenting increase in oil rig count has been driven by two major forces: the sustained, high price of the commodity and the promise of improved oil production using the technology that has transformed the gas sector. Mr. Stepp elaborated that the technology referred to in the quote was horizontal drilling and hydraulic fracturing. He looked at a map of the Baker Hughes oil rig count in Bakken, North Dakota on slide 63. According to the Baker Hughes website and app the current active rig count was 196; all of the rigs were for shale "oil play," a strategy not currently used in Alaska. He stressed that there was a substantial amount of infrastructure in North Dakota compared to Alaska's North Slope. The map indicated the presence of many state highways and county roads that provided access to infrastructure hydraulic fracturing technology. 1:11:40 PM Senator Paskvan turned to slides 69 and 70: "Other Oil Producing Regions Enjoying Production and Employment Booms." He referred to an article: Alaska Economic Trends: Alaska's Oil Industry September, 2008 (copy on file). He believed that it was a fact that there had been dramatic improvements in technology in the past decade. The article addressed examples including, horizontal drilling, ultra extended-reach drilling, 3-D and 4-D seismic surveys, drill bit sensors, and other advancements that reduced the number of wells that needed to be drilled; the number was significantly lower than it was ten years earlier. Slide 70 addressed that the national oil and gas industry had been a leader in productivity gains throughout the 1990s and that the industry had been able to perform more work with fewer workers (page 6 of the Alaska Economic Trends: Alaska's Oil Industry September, 2008). He furthered that the industry goal of fewer workers did not match up with the state's goal of increased employment for Alaskans in the industry. He stressed that policy makers should expect to see continued advances in technology given the industry's motivation to continue the development of new technologies to perform more work using fewer workers. Senator Paskvan directed attention to slide 71 that compared Alaska to other oil producing states. Based on the size of Alaska's oil industry work force a person would not guess how important oil was to the state's economy according to the Alaska Economic Trends: Alaska's Oil Industry September, 2008. He cited from the report that "Alaska produced 15 percent of the nation's domestic oil supply in 2007 but employed only 3 percent of the U.S. oil and gas work force...(page 10)." 1:14:10 PM Senator Paskvan pointed to slide 72 that continued to focus on how Alaska compared to other oil producing states: One big reason is simply that Alaska's oil fields enjoy large economies of scale. Prudhoe Bay is the largest oil field in the nation and doesn't need a huge work force to produce its oil... In Texas, Oklahoma, Wyoming and other oil-producing states, some oil is produced from very small fields. There are 400,000 marginal fields or stripper wells operating in the U.S. and a stripper well produces 10 barrels of oil or less per day. In many of the states, there are literally thousands of families and small companies engaged in producing oil - something nearly totally absent in Alaska. Senator Paskvan recalled that when legislators had been in Texas in 2011 they had been told that the average Texan well produced less than 5 barrels a day; something unknown to Alaska where the production per well greatly exceeded the amount. He read from slide 73 "Other Oil Producing Regions Enjoying Production and Employment Booms": Technology advances lead to more drilling and more jobs in the new, unconventional (i.e., shale) oil plays in North Dakota and Texas. At the same time, technology advances lead to fewer wells and fewer jobs in the mature, conventional oil plays on Alaska's North Slope. Senator Paskvan relayed that the state awaited the application of technology in conventional resources in heavy and shale oils and hoped for breakthroughs in the area in order to compare to Texas and North Dakota. 1:16:23 PM Senator Paskvan discussed slide 74 "Competition is High - Many Other Areas to Invest Around the World." He observed that the Alaska North Slope remained a world class basin; the Prudhoe Bay field was one of the ten largest fields in the world. He pointed to the vertical integration of the "big three" on the central North Slope [BP, ConocoPhillips, and ExxonMobile] and discussed that dollars were made by distribution from the upstream to midstream and at the wellhead. The industry was in a transition from "majors only to mid-majors and independents." He related that national oil companies had limited the areas in which investments could be made. The final bullet point addressed the concept of immobile capital including sunk costs; the incentive was to keep areas functioning as long as possible; a significant Central North Slope infrastructure the that remained attractive to the industry. 1:17:57 PM Senator Paskvan reviewed components included in SB 192 beginning on slide 76: "CSSB 192(RES) Rationale and Overview." He highlighted that the legislation: · Preserves Industry-Friendly Components of ACES · Reduces the Rate and Cap of Progressivity · Rewards Increased Production · Establishes a Gross Minimum Tax · Separates oil and natural gas for purposes of calculating the progressivity portion of the production tax · Creates an Oil Information System Senator Paskvan elaborated that the goal of the oil information system was to make the access to information more readily available to policy makers. 1:19:29 PM Senator Paskvan highlighted industry-friendly components of Alaska's Clear and Equitable Share (ACES) that SB 192 would preserve. Expenditures and transportation costs were preserved so the calculation of production tax was applied after the removal of the deductions. The bill maintained the current tax credits. He explained that for the same dollar a company could deduct a 20 percent credit (a company could deduct 100 percent of the dollar spent in the year it was spent), which was a powerful investment incentive. The royalty rate that ranged from 12.5 percent to 16 percent was preserved and was attractive to the industry; royalty rates ranged from 25 percent to 30 percent in other states including North Dakota and Texas. The concept of royalty modification was sustained; if an operator was able to prove a need for assistance the Departments of Revenue and Natural Resources could reduce the royalty down to as low as 3 percent to allow the fields to continue production. 1:21:34 PM Senator Paskvan addressed the progressivity rate and cap reduction that would occur under SB 192 (slide 78). The bill retained the original trigger of $30 in production tax value (PTV). He explained that the PTV was assessed after deductions for transportation costs and for qualified and operating expenditures. The PTV was a $30 gap that was maintained at the base 25 percent, at which point the progressivity rate was reduced from a 0.4 per dollar increase in PTV to a 0.35 per dollar increase that was capped at 50 percent. At 50 percent there was a second trigger on the progressive tax rate calculation to further reduce the rate of progressivity from 0.35 per dollar to 0.1 per dollar up to 60 percent. The 60 percent progressivity cap was a reduction from the current 75 percent cap. He stressed that the reductions were significant and material. Senator Paskvan pointed out that the bill would reward increased production (slide 79). He relayed that a joint Senate Finance and Resources Committee meeting had heard from petroleum consultant Pedro van Muers who had addressed the concept of an allowance for an increase in new oil or incremental oil; it had been deemed important that the bill provide incentives based on the concept. An allowance was included that would reduce a company's PTV by $10 for new and/or incremental barrels produced. 1:23:54 PM Senator Paskvan communicated that the bill would establish a gross minimum tax of 10 percent on the legacy fields of Kuparuk and Prudhoe Bay to ensure that the revenue streams would always maintain a minimum floor. In addition to the adjustment for the oil industry at high oil prices the bill factored in the potential for oil price volatility and the need to balance the risk to the state at low oil prices. He relayed that consultants had expressed the need for ACES to be durable in a wide range of price environments; the provision helped achieve that goal and protected the state at the downside. 1:25:17 PM Senator Paskvan reviewed the decoupling of the oil and natural gas taxation systems on slide 81. He explained that the tax rate applied in Alaska was based on the combined BTU [British Thermal Unit] value of oil and gas; oil and the BTUs created by oil were valued substantially higher than BTUs of natural gas. There was a dilution effect that dramatically reduced revenue streams to the state if the taxes were not decoupled. The legislation removed the dilution effect by having progressivity calculated distinctly for oil and gas. Senator Paskvan detailed that SB 192 would create an oil and gas information system (slide 82); it was believed that as much historical and current oil and gas information as possible should be available to policy makers to help them make decisions based on substantive data. The Alaska Oil and Gas Conservation Commission (AOGCC) would be required to develop the electronic Petroleum Information Management System in order to make information more readily available to policy makers. 1:27:20 PM Senator Paskvan believed that there was more reason for optimism related to Alaska's future than ever before (slide 84). There were 7 billion to 8 billion barrels of conventional oil on the Central North Slope; additionally there were other resources including, heavy and shale oils, undiscovered conventional oil, Outer Continental Shelf in the Beaufort and Chukchi Seas, National Petroleum Reserve- Alaska, and the Alaska National Wildlife Refuge. The North Slope was worth more currently than it had been over 30 years earlier because the value of oil had increased. He noted that spending forecasts were up; there had been significant work performed below ground in well workovers and there had been a rebuilding of infrastructure below and above ground. He believed the work would set the stage for a "viable and vibrant" oil industry for decades to come. He recalled that Cathy Foerster with AOGCC had reported that the North Slope was healthy. He agreed with the Department of Natural Resources (DNR) advertisement that read: "Alaska: We're Open for Business"; he believed that the state was competitive and had a world class resource to offer. He pointed to a recent Petroleum News headline "North Slope Booms"; legislators had been told in the past year that exploration on the North Slope was at a level that had not been seen in 40 years; as such, there were currently not enough rigs to perform all of the work that North Slope operators wanted. He referred to a practice called "hot sheeting" where workers alternated sleeping in beds due to the numerous employees working on the North Slope. Senator Paskvan concluded that Alaskans wanted to see the legislature act like a sophisticated owner of a world class resource and expected that Alaska would obtain the maximum value for its resources for its citizens. 1:30:47 PM Senator Thomas wondered whether members' packets included the following detailed information: a memo from Mark Meyers regarding mergers and market concentrations, Prudhoe Bay development history and future potential (slides 31 through 33), and the optimization of production from mature fields (slide 34). Senator Paskvan replied that his office would provide the articles and any additional information that the committee wanted. Senator Thomas referred to slide 60 and wondered whether Senator Paskvan had heard from the Department of Administration or DNR that remarks made by Kevin Banks to the U.S. Senate the prior year were false or misleading. Senator Paskvan replied in the negative. He believed the remarks were true at the time they were made and continued to be true. 1:32:13 PM Co-Chair Hoffman referred to an unlabeled handout from DNR's Division of Oil and Gas; it stated that the past two years of lease sales of the North Slope successfully leased a total of 1,276,000 acres to small companies. He asked how many wells had been drilled on the leases in the past two years. Senator Paskvan responded that he did not have the information. Senator Stedman would ask DNR to respond to the question at a later time. 1:32:57 PM Senator Ellis asked about any Senate Resources Committee discussions related to lease terms and the duty to produce. Additionally, he was interested in any discussion on state direct financial investment (SDFI) to better align industry and state interests. He asked about facilities access; he had heard from individuals in the industry that there was no problem with facilities access and that it was a commercial transaction that could occur in the future. Senator Paskvan affirmed that all of the topics had been discussed in the Senate Resources Committee. The ideas from members were valid, but the issue was whether tax legislation should be confined to the tax components. He believed that there should be some "footage on the cutting room floor" to keep the bill as precise as possible. He referred to a slide in the presentation that included remarks made by Bob Bartlett at the Alaska Constitutional Convention; Mr. Bartlett had discussed the acquisition of large tracks of land with the intent not to purchase. The Senate Resources Committee had discussed that there were exclusive rights provided under the lease structure that could be for 10 years where no activity occurred; the question was would the lease be tendered back to the state. The topics of duty to explore, produce, and sell had been a source of significant discussion in the committee. He hoped that issues would be better developed throughout the legislative session, particularly relating to the duty to produce. 1:36:22 PM Senator Olson referred to the Gleason Decision (slide 36). He asked whether there were any points in the decision that were in the repeal or reconsideration process that may change the date from 2065 or 2075. Senator Paskvan answered in the affirmative. There had been a state request for reconsideration of the decision. He elaborated that he prior week Judge Guidi had denied the state's application with respect to one component of the decision (the case had been transferred to Judge Guidi given that Judge Gleason was made a federal district court judge); Judge Guidi supported Judge Gleason's decision. He expected that the decision would be appealed, but as of yet the appeal for tax years 2007 through 2009 had not occurred. 1:38:27 PM AT EASE 1:43:30 PM RECONVENED