CSHB 325(FIN) am No. Slope Heavy Oil Royalty Modification  CHAIRMAN LEMAN announced CSHB 325(FIN) am  to be up for consideration. ED BAIN, OXY USA, explained that Oxy has an 8.8 percent interest in the Milne Point Unit. They were one of the original owners and have participated in the commercial development since it was initiated about 12 years ago. He said the shallow well oil sands were not economic to develop and current production occurs only from the Green Area Tract 14, about 3,000 barrels per day for 21 wells. They support the Oil and Gas Policy Council's recognition that an incentive is needed for heavy oil and, therefore, support HB 325. SENATOR FRANK asked Mr. Bain to explain some of the company's costs that were exhibited to the committee on an overhead projector. MR. BAIN said that he thought HB 325 went too far with the two percent floor that was added to the holiday. He provided other scenarios like 450 barrels per day with a two percent royalty which would add one year of royalty reduction to HB 325. A total of three percent royalty for a period of eight years would be required to get to the same level of profitability for a $4 million investment. Number 147 SENATOR FRANK asked what exactly made heavy oil more expensive to produce. MR. BAIN replied that the biggest hurdle is the up-front cash flow rates. They also produced at a low rate. He illustrated that a North Slope well might bring in typically 5,000 barrels a day, but the very best heavy oil wells produce less that 600 barrels per day. They expect a 40 year life with heavy oil and they get about 1/2 the recovery compared to lighter oils. SENATOR PEARCE asked if they paid a penalty on the quality bank for the pipeline. MR. BAIN replied that it's a poor crude and their tariff cost is higher. They currently have a $6 deduct going to the West Coast market. Number 299 SENATOR FRANK asked how the Schrader Bluff accumulation related to West Sak. MR. BAIN replied that the two sand groups they produce are basically West Sak sands. MR. BAIN explained that the next figure shows the progression of time with ARCO's first West Sak pilot well done where they spent over $100 per barrel trying to get heavy oil to work. They spent about $10 per barrel when Conoco was the operator and the analysis he is showing them for a typical well is about $3 per barrel. The reason it's much cheaper is because they are doing further development from existing pads. Number 351 CHAIRMAN LEMAN asked him to explain the difference between $2.90 and the $1.80 that was represented last week by BP. MR. BAIN replied that their difference is based on cost demonstrated to date and BP's involved more speculative goal type of costs and a projected business plan. He said that their operating expenses would be about the same level as the capital expenses, about $2.80 or $2.90 per barrel. MR. BAIN said the last figure was a synopsis of the University of Alaska study done to assess the fiscal impact of significant heavy oil development such as full or partial development of the Milne Point Unit's heavy oil. He said essentially there would be the creation of 322 nine-year jobs associated with the capital phase, which would a drilling of 20 to 40 over a nine-year period of time, and then the creation of 122 41-year jobs, basically careers. Although this is not a royalty for jobs bill, there are a lot of jobs associated with this level of expenditure over this period of time. Number 401 SENATOR LINCOLN asked how he defined "Alaska resident." MR. JON TILLINGHAST, Milne Point Unit Attorney, explained the term was from the UAA of study and they didn't give a definition of Alaska resident. He thought it meant long-term resident, because the jobs were so long-term. SENATOR LINCOLN said she would be interested to compare what their company projects with resident and non-resident employees. MR. TILLINGHAST replied that the UAA report broke down the number of jobs that would go to residents and non-residents based on their analysis and experience. The jobs listed on the chart are only the jobs projected by UAA. There would be additional jobs going to non-residents and the UAA's conclusions were that of the total jobs, 75 - 80 percent would be filled by Alaska residents. Number 428 MR. TILLINGHAST added that they feel the 15 percent hurdle rate was within the realm of industry standard when they presented it to the Oil and Gas Policy Council. Arthur D. Little did a report for them that mentioned several times that to encourage new projects you need to get over 15 percent to get most oil companies to look at it. Also, in reference to Senator Frank's earlier question about what made heavy oil more expensive to produce, he said that low production rates and high transportation costs were mentioned, but added that some of the attributes which make heavy oil particularly on the North Slope difficult to produce is that it lifts slowly because it is heavy and it needs artificial lift to pump from the beginning and also the oil is entrained in sand. Gravel packs need to be installed to separate the sand from the oil. These get clogged and need to be replaced. Another thing is that because the oil is so shallow the oil is very cold and heat tapes are needed to keep the oil warm enough. SENATOR FRANK asked what he thought was the most expensive producing field was. MR. TILLINGHAST replied that he didn't know and thought BP could give him an answer, but he cautioned against giving an across-the-board comparison, because of each unit's unique features. MR. TILLINGHAST said he had an amendment which clarifies the intent of the royalty which is if you take advantage of the oil relief granted by this bill, you can't apply for a royalty over the next 20-years for the heavy oil well you have already gotten relief for under this legislation. REPRESENTATIVE GREEN commented that he hadn't seen the amendment. CHAIRMAN LEMAN asked him to review it and give them his opinion. CHAIRMAN LEMAN announced they would set CSHB 325(FIN) am aside and deal with some other issues. Number 290 CHAIRMAN LEMAN announced CSHB 325(FIN) am  to be back up for consideration. MR. TILLINGHAST explained that Oxy thought there were a number of criteria that are important for an effective incentive. One is that it is sufficient to materially impact project economics. The second thing is that it should be an up-front incentive because they are trying to encourage new capital investment. Other states have found that royalty holidays and severance tax holidays are the most effective way of encouraging new investment as opposed to having a reduced royalty over the life of the field which is more effective if you are trying to reduce somebodies operating costs over the long run. The virtue of the "purple option" is that the three percent royalty is about 25 percent of Oxy's lease royalties. Therefore, if it's the legislature's desire to assure that the Permanent Fund's constitutional share of royalties continue to go into it, it gives the legislature the ability to do that. CHAIRMAN LEMAN asked on page 1, line 15, at what point it was intended that the $15 price be measured. MR. TILLINGHAST answered at the well-head lack meter. CHAIRMAN LEMAN asked on page 2, line 22, why a two-year period was selected for the production records instead of using the same period the State has for its audit rights for taxes and royalties. MR. TILLINGHAST replied that they ought to be consistent whatever they are. He said the issue came up in the House and they couldn't find out what the audit period was for royalty records in generally. CHAIRMAN LEMAN asked on page 3, line 8, if the 450 should be changed to 500. MR. TILLINGHAST said that was correct and he added there was another correction needed on page 2, line 3 in the definition of "actual initial drilling", but the subparagraph only refers to "initial drilling." "Actual" should be deleted, he said. Number 205 REPRESENTATIVE GREEN said he had no problem with their first proposed amendment. CHAIRMAN LEMAN asked on page 3, line 9, what happens if oil with the higher gravity is blended with lower gravity oil to produce a blend that is higher than the low gravity oil, but lower than the 20 degrees API cutoff in the bill. MR. TILLINGHAST replied that wouldn't be a problem at Schrader Bluff because there are no dual completions. REPRESENTATIVE GREEN answered that they are really talking about a very small area. MR. TILLINGHAST added that an up-front incentive is superior from the State's perspective because heavy oil fields have a very slow decline rate and an up-front incentive will net the State more royalties than a similar incentive spread out over the life of the field. TOM NEISWANDER , Milne Point Commercial Manager, BP Exploration, said this is a resource they have known about for a very long time. It is undeveloped despite three tries. They have developed 15 million barrels out of that 26 billion that are in-place. The reason for that is that heavy oil reserve is uneconomic. Their bottom line on development costs is $2.75 per barrel. Add that to the other typical characteristics of this project and that makes it uneconomic. TAPE 96-58, SIDE A Number 001 MR. NEISWANDER said that the industry needs to continue to work at bringing its costs down and increasing the initial production rates of those wells. He said it takes spending money to figure out how to do these things. He thought the State should encourage those types of initiatives and HB 325 is a simple, clear tool to help them do that. CHAIRMAN LEMAN apologized for interrupting, but said there were other time constraints and he thanked him for his testimony. He said they would prepare a Resources SCS to HB 325 and set it aside.