SENATE BILL NO. 192 "An Act relating to the oil and gas production tax; and providing for an effective date." JANAK MAYER, MANAGER, UPSTREAM AND GAS, PFC ENERGY, displayed a PowerPoint presentation titled, "Discussion Slides: Alaska Senate Finance Committee. March 30, 2012." Mr. Mayer discussed slide 2, "Difficulties in Existing Fiscal Structure." The incorporation of progressivity into the Profit- Based Production Tax (Net) in ACES creates two significant problems: Large-scale gas production at low gas prices could in the future significantly reduce production tax revenue from existing oil production. -Resolving this problem within the framework of ACES requires significant complexity. -Approach to decoupling in CSSB 192 requires ability to split costs between oil and gas production, creating high degree of administrative burden, and limiting capacity of state to effectively audit. Options for incentivizing new production are limited, and relatively complex. -Proposed incentives within existing framework focus on either allowances to reduce Production Tax Value, or revenue exclusions (tax holiday). Mr. Mayer spoke to slide 3, "Summary of Progressive Severance Tax (Gross) Structure." A Progressive Severance Tax (Gross) option would instead remove progressivity from the Profit-Based Production Tax (Net), instead levying this tax at the flat, base rate of 25 percent. To retain an element of progressivity, a new Progressive Severance Tax (Gross) would then be added to the system. The tax would: -Be non-deductible for Profit-Based Production Tax purposes. -Be levied on gross production (net of royalties). -Be levied solely on oil. -The tax would use a progressivity structure not dissimilar to that under the current system, with progressivity coefficients that apply at different thresholds. Mr. Mayer discussed slide 4, "Summary of Progressive Severance Tax (Gross) Options." The first option for the Progressive Severance Tax would use the following parameters: 1. No severance tax below $65 Gross Value at Point of Production (GVPP). 2. Progressivity of .25 percent commencing at a threshold of $65 GVPP. 3. At $125 GVPP, a tax rate of 15 percent is reached. At this point, progressivity is reduced to 0.05 percent. 4. Progressivity is capped 20 percent A second option, which would freeze government take at 70 percent at $100/bbl might look like this: 1. No severance tax below $60 Gross Value at Point of Production (GVPP). 2. Progressivity of .25 percent commencing at a threshold of $60 GVPP. 3. At $100 GVPP, a tax rate of 10 percent is reached. At this point, progressivity is reduced to 0.03 percent. 4. Progressivity is capped 20 percent. 9:56:07 AM Mr. Mayer explained slide 5, "Benefits of Progressive Severance Tax (Gross) Structure." By removing progressivity from the Profit-Based Production Tax (Net), and having the progressive element of the structure be a Progressive Severance Tax (Gross), two things become much easier to achieve. -The issue of gas production reducing production tax revenue ceases to be a problem without progressivity in the Profit-Based Production Tax. Complex provisions to split costs between oil and gas production under CSSB 192 are thus no longer required. -Significant incentives can be provided to new production, by eliminating or reducing the Progressive Severance Tax (Gross) for new production. A wide range of levels of government take can be achieved using this structure, depending on the parameters applied. Mr. Mayer discussed slide 6, "WTI Light Sweet Crude-Forward Curve." He stated that the WTI marker, because was considered the most liquid. He stated that WTI currently traded at a discount. In terms of spot prices, there may be a ten or more dollar differential. The important point was the shape of the curve, and the fact that 2020 delivery dates could be below $90/bbl. He stated that the curve represented March 29, 2012 contract prices for delivery from everything from May 2012 to November 2020. Mr. Mayer explained slide 7, "FY 2013 Revenue Comparison." He stated that the chart had been extended from the $150/bbl level to the $200/bbl level, and added a second severance tax option. Severance tax option 1 displayed progressivity continuing up to $125/bbl; and severance tax option 2 stopped at $100, but kicked in at a slightly lower level, and would "freezes" take at the 70/30 split for FY 13. He stressed that the displayed revenues were slightly than the first option that was presented the day prior, however the revenues were broadly similar to those under the Alaska Clear and Equitable Share Act (ACES). 10:00:37 AM Co-Chair Stedman asked for a clarification on the two different severance tax options, specifically regarding severance tax option 2. Mr. Mayer looked at slide 8, "FY 2013 Revenue Comparison." He looked at the difference between the total state revenue from production tax on the left and the cash to companies on the right hand side. He stated that there was a main divergence showed a slight change around the $120/bbl level that came from the different progressivity coefficient that is applied under CS SB 192: .35 percent rather than .4 percent. When the level is taken $120/bbl to $200/bbl, there is a small split displayed, as the cap in CS SB 192 is applied. He stressed that below $200/bbl, there was very little difference. He stated that the blue line represented severance tax option 1. The scenario was based on progressivity on the progressive severance tax would kick in at a rate of $65/bbl, and be progressive at a rate .25 percent up to a level of $125/bbl. From that point on, it would continue at a rate of .05 percent until a cap of 20 percent was reached. Co-Chair Stedman noted that the chart did not include the $400 million in 20 percent capital as reflected on slide 7. Mr. Mayer replied in the affirmative and that all of the 2013 numbers were prepared consistent with DOR methodology, where their production tax forecasts did not reflect the credits. The credits were calculated separately in the state budget. The reason the $400 million was not included, was because those credits were entirely exogenous to the economic model that produces the numbers. 10:04:53 AM Co-Chair Stedman stated that the $400 million was used to calculate in the 2013. He wanted to be clear in the future whether the credits represented $400 or $800 million. He wondered why the $400 million was not included in the chart. Mr. Mayer responded that he did not include the $400 million because it was attributed to projects that were not necessarily producing. The additional $400 million in credits were not subject to production tax. Co-Chair Stedman stated that he would like to see the credits shown in the chart. He observed that the committee would like to look at the whole gross value and not just adjusted numbers. Senator Thomas observed that a 1 percent tax at $120/bbl, could result in about $170 million. He stressed that $400 million or $800 million was a "big swap in cash." Co-Chair Stedman looked at the severance tax option 2 on slide 7, and surmised that the concept was to hold the tax flow constant at $100/bbl and below. However, more cash would be moved to industry at $100/bbl and above. Mr. Mayer responded that there was a 70/30 percent split in both state and federal governments. He stated that the 70/30 split, under this proposal, would make every additional dollar above $100/bbl be broken, so 30 percent would to the company, and 70 percent would go to the combined federal and state governments. Co-Chair Stedman asked if the price was frozen at $100/bbl Mr. Mayer responded in the affirmative. Co-Chair Stedman wondered if the price could be set at $125/bbl. Mr. Mayer did not respond. 10:12:11 AM Mr. Mayer displayed slide 9, "FY 2013 Revenue Comparison", which compared the total state take with the total government take. Mr. Mayer explained slide 10, "ACES (FY 2013)." He stated that the slide outlined the dollars to the treasury for each of the components of the system, for each of the regimes. Co-Chair Stedman noted that the committee had not had a chance to review the slides. He looked at slide 10, and wondered if the revenue forecast was with or without the additional $400 million in credits. Mr. Mayer responded that the slide did not include the additional $400 million in credits. Co-Chair Stedman felt that information about whether or not the $400 million was represented should be "footnoted" in some of the slides, in order to reduce confusion. He remarked that the numbers were homogenized, but without the $400 million applied. He felt that a homogenized analysis should include all credits, especially $400 million, specifically all credits applied against the treasury: net cash back on the table. Mr. Mayer replied that in order to produce the numbers for a model, it was imperative to look at credits that came from existing production, so one could examine the estimate of the costs associated with the production would be. He remarked that the reason the presentation was in its current form, was for consistency with the DOR figures and the current state budget structure. 10:17:19 AM Mr. Mayer discussed slide 11, "CSSB 192 (FY 2013)." When looking at the overall government take figures, there was not much difference from the current structure. The reason there was not much change, the 60 percent cap did not bind at a price level of $230/bbl. He furthered that if there was an examination of a range of years, across the project life span, the impact of inflation would display a difference. The only difference that is showcased, was the impact of the .35 percent rather than the .4 percent progressivity coefficient. Mr. Mayer explained slide 12, "Severance Tax-20 percent Maximum (FY 2013) .25 percent progressivity from $65 to $125, then.10 percent progressivity." He explained that the two graphs displayed the difference between a .25 percent progressivity and a .10 percent progressivity from $65/bbl to $125/bbl. Mr. Mayer discussed slide 13, " Severance Tax - 20 percent Maximum (FY 2013) .25 percent progressivity from $60 to $100, then .03 percent progressivity." He explained that the two graphs displayed the difference between a .25 percent progressivity and a .03 percent progressivity from $60/bbl to $100/bbl. Co-Chair Stedman asked for a clarification on slide 7 and asked if option was a $100 million. Mr. Mayer replied in the affirmative and declared that it was a function of progressivity kicking in at the $60/bbl level, rather than the $65/bbl level. He furthered that, under severance tax option 2, total state take was almost identical to what it would be under CS SB 192. Co-Chair Stedman noted that the sharing relationship would increase, if there was an increase to $110 million. Mr. Mayer agreed. Mr. Mayer discussed slide 14, "Incentives for New Production." Significant incentives can be provided to new production, by eliminating or reducing the Progressive Severance Tax (Gross) on any combination of: -Production from new areas. -Production from new plans of development (determined through the regulatory process to be for "new production"). -Production above a fixed decline rate. Here, a reduced rate of Progressive Severance Tax has been modeled, using the following parameters for new production: -Base rate of 0 percent -Progressivity of .05 percent commencing at a threshold of $65 (gross value at point of production). -Progressivity is capped 5 percent. Following slides show a new, high-cost 10 mb/d development under -The regular rate. -The reduced rate (with a time limit of 7 years). -The reduced rate (with no time limit). 10:23:11 AM Mr. Mayer explained slide 15, "Noted on Impact of Inflation." Under ACES, thresholds and coefficients for progressivity are specified in nominal terms, without indexation. -As a result, when economics over the long-term rather than just 2013 are examined, we see the effects of 'bracket creep' or 'stealth tax.' -In real terms, as prices increase, thresholds for progressivity decrease, and the higher take that comes with progressivity occurs at lower and lower price levels. Severance tax options are also currently shown assuming nominal thresholds. -As a result, in the charts, the impact of the severance tax can be seen below the $60/$65 level at which it applies - a result of bracket-creep over the lifetime of a project. It is strongly worth considering the application of price indexation to thresholds for progressivity. Mr. Mayer discussed slide 16, "ACES (New Development)." He remarked that the new development under ACES had negative NPV at every price level, with a rate of return of approximately 10 percent at the $100/bbl level. It faced government take, over the project life cycle, of around 78 percent at the $10 level, and rising to $85 percent at the high $200/bbl levels. Mr. Mayer explained slide 17, "CSSB 192 (New Development)." He stated that under CSSB 192, the reduced progressivity coefficient had a small impact. The rate of return for the project did not shift, but there was growth from a slightly negative number to a slightly positive number at $100/bbl. With the impact of inflation at the higher levels, government take was brought down to north of approximately $180/bbl. 10:26:25 AM Mr. Mayer discussed slide 18, "Severance Tax-20 percent Maximum (New Producer) .25 percent progressivity from $65 to $125, then .10 percent progressivity." He pointed out the leveling of the life-cycle, including factoring the impact of inflation at the $100/bbl to $110/bbl level with a 76 percent split moving up the price deck. Mr. Mayer explained slide 20, "Severance Tax-20 percent maximum, (New Development)." He explained that the slide represented what a project would look like under the severance tax option 2, where progressivity kicked in at $60/bbl and extends to $100/bbl. Mr. Mayer looked at slide 22, "Severance Tax - 20 percent Maximum with first 7 years at 5 percent (New Producer) .25 percent progressivity from $60/bbl to $100/bbl, then .03 percent progressivity." He explained that the slide displayed the same factors as slide 20, but applied a time limit of seven years. 10:31:30 AM Mr. Mayer discussed slide 23, "20 Year Revenue Impact of Reduced Rate of New Production (Using Severance Tax Option 1)." He stated that he redid the analysis of the possible 20-year revenue of a reduced rate for new production. He ran the numbers again, but he realized he was attempting to pull together a large amount of data in a short period of time. Co-Chair Stedman wondered if the chart included credits. Mr. Mayer replied that the charts included the credits for the existing production. Co-Chair Stedman furthered that the chart should reflect the impact of the legacy fields. Mr. Mayer responded in the affirmative. Mr. Mayer looked at slide 24, "Regime Competitiveness: Relative Government Take." He stated that the number was not too bad for government take at $60/bbl. Co-Chair Stedman felt that Alaska would be more attractive than North Dakota at $60/bbl. Mr. Mayer agreed, but reiterated that Alaska was not more attractive than North Dakota at current prices. Mr. Mayer discussed slide 25, "Regime Competitiveness: Relative Government Take." He pointed out that at $80/bbl, ACES for existing producers was below other regimes, other than Norway. Mr. Mayer looked at slide 26, "Regime Competitiveness: Relative Government Take." At $120/bbl, the gap started to widen. 10:37:39 AM Mr. Mayer looked at slide 29, "Regime Competitiveness: Relative Government Take." At $140/bbl, ACES and CSSB 192 were basically the same as Norway, while the two severance tax options were significantly more competitive. At $160/bbl, ACES and CSSB 192 was nowhere near the top of the regimes. Mr. Mayer discussed slide 30, "Regime Competitiveness: Relative Government Take." He stressed that at $180/bbl, a split could be seen between ACES and CSSB 192. Mr. Mayer spoke to slide 31, "Regime Competitiveness: Relative Government Take." He pointed out that at $200/bbl, ACES was matched with Algeria and other high taxing regimes. Co-Chair Stedman looked at the remaining slides, and noted that they displayed a 7 year time horizon. Mr. Mayer responded that the second set of slides represented economics for new development, rather than an existing producer. 10:40:52 AM Mr. Mayer highlighted slides 36-39. He remarked that north of $180 to $200 for new development, ACES was at the top of the very high price levels. Co-Chair Stedman remarked that Alaska was more stable than Syria. Mr. Mayer agreed. Co-Chair Stedman noticed calculations and net present value in pricing displayed in slides 41 through 43. He requested a brief description of those slides. Mr. Mayer responded that the generic view of ACES was useful in the initial analysis. Now, that there was a micro-level of detail, the FY 13 numbers were more useful. Mr. Mayer pointed out slide 41, "CSSB 192 (Existing Producer)." The slide displayed the 79 percent maximum for CSSB 192. Mr. Mayer discussed slide 42, "Severance Tax - 20 percent maximum (Existing Producer) .25 percent progressivity from $65 to $125, then .10 percent progressivity." He stated that severance tax was frozen at current prices, so from $120/bbl and up would allow for a steady 72 percent government take. Mr. Mayer highlighted slide 43, "Severance Tax - 20 percent maximum (Existing Producer) .25 percent progressivity from $60 to $100, then .03 percent progressivity." He stated that the slide displayed the freezing at $100/bbl with a 69 to 70 percent from that point on. SB 192 was HEARD and HELD in committee for further consideration. Co-Chair Stedman discussed housekeeping.