CS FOR HOUSE BILL NO. 276(FIN) "An Act providing for a credit against the oil and gas production tax for costs incurred for conducting seismic exploration and drilling certain oil or natural gas exploration wells in certain basins; relating to the determination of the production tax value of oil and gas production; and relating to a special tax rate for new oil or gas production south of 68 degrees North latitude." 9:28:12 AM Co-Chair Hoffman MOVED to ADOPT the proposed committee substitute for HB 276, Work Draft 27-LS1193\W (Nauman, 4/13/12) as a working document. 9:28:28 AM Co-Chair Stedman OBJECTED for the purpose of discussion. DARWIN PETERSON, STAFF, SENATOR BERT STEDMAN, discussed the changes in the new committee substitute, version W. He shared that the following sectional analysis described how the legislation arrived at a 30 percent allowance on new production from new fields, which were not in existing units. Section 1: AS 43.55.011(e) is the 25% base tax. In order to calculate the base tax for a new lease or property, you take the production tax value and subtract 30% gross value at the point of production for new fields and multiply by 25% to get the base tax. Section 2: As 43.55.011(g) is the progressivity calculation. You calculate the production tax value as you normally would and use that to come up with the progressivity percentage. Then you take the production tax value and subtract the incentive allowance which is 30% of the gross value at the point of production for new fields. That gives you your adjusted production tax value you will pay. Section 4: AS 43.55.020(a) is the calculation of a producer's installment payments. It just says that once you figure out what the tax will be, you pay 1/12 of that amount monthly. Section 8: AS 43.55.160(a) is the calculation of production tax value. It simply says you have to adjust the production tax value based on the new allowance in AS 43.55.162. Section 10: This section sets up the new 30% allowance for the first 10 years of sustained production or the first ten years after January 1, 2013, whichever is later. In order to qualify, a development must be in a new lease or property that is north of 68 degrees north latitude and was not part of a unit or did not have commercial production prior to January 1, 2008. 9:31:13 AM Co-Chair Stedman WITHDREW his OBJECTION. There being NO FURTHER OBJECTION, Work Draft 27-LS1193\W was ADOPTED. Co-Chair Stedman discussed a fiscal impact note from the Department of Natural Resources in the amount of $211,400 in general funds for two new full-time positions and an indeterminate fiscal note from the Department of Revenue (DOR). He added that an updated fiscal note was forthcoming from DOR. JANE PIERSON, STAFF, REPRESENTATIVE STEVE THOMSON, provided some background for the bill. BACKGROUND:   This bill was originally conceived to provide tax credits meaningful enough to attract exploration in the Nenana Basin. Fairbanks is suffering from staggering energy costs. 1. $660 million last year for space heating 2. Average KwH is 23 cents 3. Heating oil is over $4.00 per gallon and 4. And Natural Gas is at $23 Mcf and only available to 1100 customers due to shortages of supplies. Because of the high costs of energy, many people are burning wood or coal which is not helping Fairbanks meet PM 2.5, EPA standards. Some residents have had to choose between paying for necessities or keeping warm, especially during this long, cold winter. The lack of adequate gas supplies has also created a stumbling block for economic development, businesses are struggling and development has been curtailed. Yet, just 50 miles north of Fairbanks lays the Nenana Basin: 1. Where there is an exciting potential for gas and possibly oil 2. Situated adjacent to roads, the rail road and 3. Power transmission systems After working with the House Resources committee, DNR, DOR, DOL, and other communities interested in this concept the bill was developed. The bill was expanded to include drilling in other unexplored/underexplored basins or areas, and expanded to additionally include seismic exploration. Yet the original concept of the bill was preserved, which is to serve Alaskans, not only by providing incentives that could lead to commercialization of hydrocarbons for export, but also to promote exploration for oil and gas resources in frontier basins where there is a possibility for local regional use. Ever present in these discussions was how to balance the elements of this bill as a public policy: 1. The State's Priority to inspire exploration and development 2. The level of Risk that is reasonable for the state to carry 3. The total financial contribution the state is willing to make 4. And the potential for a return on the state's investment THE SPECIFICS OF THE BILL:   P.7, [Section 6 AS 43.55.025(p)] In the bill before you includes six geologic areas for exploration. (See map provided). All these areas were identified by DNR as having potential for discovery of hydrocarbons and all with some proximity to existing communities struggling with high energy costs. 1. Kotzebue and Selawick Basins 2. Nenana and Yukon Flats 3. Emmonak 4. Glannallen and Cooper River area 5. Egegik - Northern Alaska Peninsula 6. Port Moller - Southern Alaska Peninsula (DNR can address questions on how we got to these 6 areas and Representatives from Nana and Doyon can address the importance of the Nenana and Kotzebue areas) P. 4, [Section 4] With addition of these other 5 areas, the potential cost and risk to the state rose. To address this HB 276 limits the number of exploration wells and seismic exploration eligible for credits and limits the credits. 1. Exploration well credits - limits the number of wells to 4 wells in one of the areas identified on the map with no more than 2 wells in any one area. The tax credit for drilling is for 80% of the total exploration expenditures for work performed or $25 million, .whichever is less. (This is 15% more than what would currently be available in existing statute, unless the total cost is 20% over 25 million - then 65% is better). The total credit exposure is $90 million or $30 mm more than what is currently available.. However, only 15% above credits that are currently, available. 2. Seismic credits were created in this bill to attract new geophysical analysis. The seismic credits are for 4 total projects, with no more than one in any of the areas identified on the map. The credit amount is 75% of the total exploration expenditures, or $7.5 million, whichever is less. (i.e. 10% more than what is available in existing statute, unless the total is 35% over 7.5 million). The total maximum credit that would be available is $30 million. However, this is 10% more than what might be currently available. Seismic projects are subject to the same pre-qualification criteria as drilling. These credits apply to work performed after June 1, 2012 and like other production tax credits in AS 43.55.025, expires in 2016. The credit is also not stackable with other credits provided under AS 43.55.025 or AS 43.55.023. It is the intent of this bill that the quick window for these credits will create a frontier basin stampede. [Section 6] To ensure the state's investment is warranted, and exploration projects are sound, with DNR's input, prequalification criteria were created that must be satisfied before any project commences. DNR has broad discretion to weigh these factors within 60 days or as soon as practicable before approving or denying exploration well or seismic exploration credits under this bill. These pre- qualification criteria can be found for drilling on page 7, line 21 through page 8, line 2 and for seismic on page 8, lines 24 through page 9 line 2. Also key in discussions on the bill, was how the state gets a return on its investment. More geological data for state use and public release helps to expand our knowledge of the potential resources in these remote areas. It assists present and future explorers, and seismic data could very well attract new investment and development in the state, bringing the potential for increased production, tax revenues and royalties. Added as qualification for the credits under HB276 is a requirement that all exploration drilling and seismic data collected must be turned over to the state and made available for public release within two years of receiving the credit under this bill. [Section 2] The final consideration that arose was what if an explorer in one of these remote areas of Alaska is successful? These remote frontier areas are difficult to reach, face logistical obstacles, and challenges getting hydrocarbons to market. Yet producers in these areas would pay the same production tax as companies on the North Slope that already has infrastructure and access to markets. Therefore, another component was added: For those explorers in these frontier basins who reach commercial production, we gave a break on production taxes. New producers in "middle earth", commencing production after January 1, 2013 and prior to January 1, 2022, are eligible for a rate of 4% on the gross value at the point of production, or taxes under 43.55.011(e), whichever is less, for seven years following the start of commercial production. After 7 years, the tax rate reverts back to what is in existing statute. This tax rate is crafted only to apply to new production south of 68 degrees latitude and not within the Cook Inlet. This bill gives no breaks on Royalty, corporate income tax, or property taxes. What it does, is give explorers willing to take the risk to explore in these remote areas some predictability for the first seven years of hydrocarbon commercialization. This will assist these companies in obtaining financing for infrastructure and other costs associated with remote areas. This completes my presentation and I would be happy to answer any of the questions committee members may ask. 9:40:42 AM GERALD KEPES, PARTNER, HEAD OF UPSTREAM AND GAS, PFC ENERGY, began a PowerPoint presentation (copy on file). He explained that the presentation examined the changes to HB 276 that impacted exploration and production activities. He related that the legislation proposed a gross revenue allowance that would impact new oil development or new development as stipulated. He concluded that the presentation was intended to show the impact or difference between the proposed gross revenue allowance and the current policy for new oil under ACES. Mr. Kepes discussed slide 1 titled "ACES ($25/bbl Capex New Development)." He related that the slide represented a stylized new development with capital expenditures (CAPEX) of approximately $17 per barrel in a 70 million barrel field; the field would have a peak production of 10,000 barrels per day (bbl/d). He explained that at an oil price of $100 per barrel, the slide's scenario had a net present value (NPV) of $112 million and generated an internal rate of return (IRR) of 16 percent. Mr. Kepes spoke to slide 2 titled "ACES with 30 % Gross Revenue Allowance ($17/bbl Capex New Development)" and stated that it depicted the result of applying the gross revenue allowance to the same new development as slide 1. He shared that slide 2's NPV had nearly doubled in comparison to the previous slide and that the IRR had also increased to 20 percent. He concluded that the 30 percent gross revenue allowance represented a substantial difference for the low-cost new developments and reiterated that the slide showed the difference between adding the allowance versus the current treatment for new oil. Mr. Kepes discussed slide 3 titled "ACES ($25/bbl Capex New Development)." He shared that the slide stepped up the cost scale and had a CAPEX of $25 per barrel for the stylized new development. He stated that a CAPEX of $25 per barrel was more reflective of the costs for new developments in Alaska, which were away from existing infrastructure and were higher cost. He reiterated that the slide represented a 70 million barrel field with a peak production level of about 10,000 bbl/d. The slide generated an NPV of approximately $24 million and an IRR of about 11 percent. Mr. Kepes addressed slide 4 titled "ACES with 30% Gross Revenue Allowance ($25/bbl Capex New Development)." He stated that slide 4 added the 30 percent gross revenue allowance to the same development as the previous slide. In comparison to the previous slide, the IRR rose to 14 percent and the NPV also increased by about $100 million to $121 million. He related that the slide showed the impact of adding the new gross revenue allowance at higher costs versus the current treatment of oil in the ACES regime. 9:45:14 AM Mr. Kepes discussed slide 5 titled "ACES ($34/bbl Capex New Development)." He shared that the slide's development represented the highest cost range examined and that it had a CAPEX of $34 per barrel. He opined that under ACES, this sort of investment was unattractive and generated a negative NPV and a fairly low IRR. Mr. Kepes explained slide 6 titled "ACES with 30% Gross Revenue Allowance ($34/bbl Capex New Development)" and stated that it applied the gross revenue allowance to the same development as the previous slide. In comparison to previous slide, the NPV on slide 6 had moved into the positive and the IRR had increased to about 10 percent. He reiterated that the intent of the slides was to demonstrate the specific difference created by applying the 30 percent gross revenue allowance to a range of low-cost, medium- cost, and high-cost new developments of oil that were outside and away from existing infrastructure and production. Co-Chair Stedman gave a brief explanation of the 30 percent gross revenue allowance and pointed out that the concept had arisen from previous work on enhancing new oil production with gross progressivity calculations. If the committee could not go to a gross calculation and restructure ACES, enhancements for new oil needed to be addressed within the current ACES structure. He explained that the 30 percent gross revenue allowance was designed to replicate the returns of prior legislation that the committee had spent a month or so working on. He offered that if ACES was restructured in the future, the gross revenue allowance would probably also be restructured. He explained that he wanted the public to be informed as to the background and numbers surrounding the concept. ELIZABETH HENSLEY, NANA REGIONAL CORPORATION, JUNEAU (via teleconference), testified in support of the legislation and expressed appreciation for the aspects of the bill that incentivized exploration in the Kotzebue and Selawick Basins. 9:48:52 AM Co-Chair Hoffman MOVED to report SCS CSHB 276(FIN) out of committee with individual recommendations and the accompanying fiscal notes. There being NO OBJECTION, it was so ordered. 9:49:12 AM SCS CSHB 276(FIN) was REPORTED out of committee with a "do pass" recommendation and with a previously published indeterminate fiscal note: FN3(REV) and a previously published fiscal impact note: FN4(DNR).