SB 271-OIL AND GAS PROD. TAX: CREDITS/INTEREST  3:33:43 PM CO-CHAIR MCGUIRE announced consideration of SB 271. PAT GALVIN, Commissioner, Department of Revenue (DOR), gave an overview of SB 271, the governor's oil and gas tax credits bill. He said the bill deals with three primary themes, the first is to increase tax incentives available for activities that will result in more oil and gas jobs, the second is to provide all taxpayers with the full value for incentives currently offered, and the third is to provide fairness in administration of the production tax. This goes to the provision dealing with the application of interest for underpayment of taxes due to a retroactive application of a regulation. SENATOR STEDMAN joined the meeting. 3:36:04 PM COMMISSIONER GALVIN said SB 271 consists of four main components: one is that it establishes a 30 percent credit for well-related expenditures (infield drilling) that would fill an existing space in the oil and gas credit area where they already provide a blanket 20 percent credit for capital expenditures across the board. If it takes place outside of existing areas of activity they provide either a 30 or a 40 percent credit. This credit is intended to target well related expenditures within existing fields. Second, it eliminates the current requirement that the capital credits must be spread over two years and allows them to be used in the year in which they are earned. The third one is to eliminate the current reinvestment requirement (taxpayer must demonstrate that they are reinvesting in the two subsequent years) for those taxpayers who want the state to buy their credit when they don't have current production tax obligations to put their credit up against. They have found it could provide a barrier to companies who are looking to partner on individual exploration projects where they may come in as an investor for a particular well program and then see what happens after that. Their impression of their ability to get full value of the credit will be based upon whether they expect to make additional investments in the future. Finally, it provides a waiver of interest when retroactive regulations are put in place that result in an underpayment in a past tax return. 3:39:45 PM COMMISSIONER GALVIN provided more detail to the first component, the 30 percent credit for infield drilling. They saw the overall level of investment and well activity raising after ACES passed, but not the number of wells being drilled. This provision raises the 20 percent credit currently available for all well-related work to 30 percent for well-work within existing units. It also provides a 30 percent credit for certain well-related operating costs that currently don't qualify for any credit. 3:41:59 PM SENATOR WAGONER asked what would insure the state will get additional production for that additional 10 percent credit. COMMISSIONER GALVIN answered there is no guaranty that the activities qualifying for the credit will be additional, because they can't easily identify what they would have done otherwise. However, the department recognizes that they have seen the level of activities among explorers increase, so they anticipate that these credits for this particular type of activity will encourage more of it. 3:43:35 PM SENATOR STEDMAN said he sees it as more of a 50 percent credit. Several years ago when they did PPT [revising the state oil tax] legislative consultants cautioned that if the state moved the credit from the 25 percent base tax it would be offering credit that wasn't needed, and he didn't recall ever discussing a credit as high as 30 percent. So he thought as they go down this road they should have some cash-flow modeling. 3:46:29 PM COMMISSIONER GALVIN said he would agree if they were looking at increasing the capital credit across-the-board from 20 to 30 percent. But here they are trying to incentivize specific activities similar to the existing exploration incentive credit program which is at 30 percent and sometimes a 40 percent for particular activities. They have modeled the fiscal impact of this based upon the expected spending they are seeing in the next couple of years. While they expect it to go up, they have estimated $250-300 million per year in additional credits being generated by this activity that would qualify for these credits. SENATOR STEDMAN said he understands these credits are targeting Prudhoe Bay, Kuparuk, and Alpine, the older side of the field with a lot of heavy oil and comparatively lower operating costs (where most of the oil and the money are). Consultant David Wood had done some work in that area and testified in Finance about concerns with some of the timing and placement of the incentives. 3:49:07 PM SENATOR FRENCH said his question goes back to the ACES debate and the model that was done by Rich Ruggerio [Gaffney Cline] and Bob George that showed high profitability for Prudhoe and Kuparuk wells of 50 percent and under almost any taxation structure. He wondered where that level of profitability plays into the governor's calculation of the size of the stimulus that is necessary, given that drilling wells there is "like shooting fish in a barrel." COMMISSIONER GALVIN said the economic modeling they did during the ACES session was based on numbers the companies (particularly BP) provided, and he thinks those were an accurate reflection. He did not believe those particular wells needed this kind of credit, but he further expects a second wave of well work that will be less economic - because either the costs are higher or the production profile would be less attractive - and those wells are not being drilled. This credit seeks to provide a broader economic uplift, looking to bring on some activities (infield drilling) that are currently being passed over. 3:52:17 PM CO-CHAIR WIELECHOWSKI asked how the $350 million fiscal note is apportioned between new wells and what they expect to be drilled because of this credit remembering the increase from the 20-30 percent in the old wells that would have been drilled anyway. COMMISSIONER GALVIN answered they don't have any projections, and technically the fiscal note is indeterminate for this bill. It is the balance between the additional credits that the state would incur because of the additional activity with the offsetting additional production; so he couldn't give him an accurate revenue impact. 3:53:45 PM CO-CHAIR WIELECHOWSKI echoed Senator Stedman in that it is important to do some kind of modeling to figure out what the state is really getting for the $350 million. He would have a hard time supporting giving it away for wells that would be drilled anyway, but if they are going to get new wells out of it, he would be more supportive. He asked how much more oil would be going into the pipeline and how much more revenue would be generated because of these credits. COMMISSIONER GALVIN said he appreciated the sentiment and felt that they would model this if they could, but without additional detail from the companies they can't do it. However, they do know that the increased credits in the exploration areas are working, and that kind of credit doesn't exist for infield drilling, and they think it is worth trying. 3:56:32 PM CO-CHAIR WIELECHOWSKI commented that it is hard for him to make a big policy call without this information, and now he is hearing that the commissioner cannot give him any confidence that one single well will be drilled as a result of this credit. COMMISSIONER GALVIN responded that he can't say specifically how much activity is going to be created, but he can say this credit will result in more favorable economics for the wells being evaluated for a decision. That will increase the likelihood that more wells will be drilled and that more production will occur. 3:57:47 PM SENATOR WAGONER asked if this credit doesn't result in any wells being drilled, then the state isn't out any money, right? COMMISSIONER GALVIN responded yes. SENATOR WAGONER asked what history he has about the wells that have been drilled over the past five years, so they can use it for comparison. COMMISSIONER GALVIN said he will have to look at how detailed their information is on specific incremental production that results from drilling activities. 3:59:03 PM SENATOR FRENCH wondered if they had looked at the Kuparuk experience where prior to the PPT tax revisions in 2006 the severance tax was nearly zero. COMMISSIONER GALVIN replied that they don't see this as falling in the rubric of lower taxes means higher production. Rather they see this as investment results in a credit off your current tax bill. It changes the dynamic significantly in terms of investment decision making. SENATOR FRENCH asked where the $250 to $300 million comes from - from projecting the current level of infield drilling activity or does it envision some modest increase? 4:00:29 PM COMMISSIONER GALVIN answered that it actually breaks the current level of total expenditures down into activities that are considered to potentially be subject to this credit. 4:01:38 PM CO-CHAIR WIELECHOWSKI asked where he gets the information to make these projections and based on these projections do they expect an increase, a decrease or the same amount of drilling compared to now. COMMISSIONER GALVIN answered that their information comes from a variety of sources. The projected overall expenditure comes from the companies, themselves, that under the current tax system have to project spending levels for a number of years in the future. They get a bit more detail on past spending from other past reports and have tried to differentiate well-related costs from non-well related costs. 4:03:09 PM CO-CHAIR WIELECHOWSKI asked again if he expects an increase, a decrease or the same amount of drilling in future years. COMMISSIONER GALVIN replied that the level of overall expenditure is expected to increase, which would lead them to expect additional wells will be drilled. It is a combination of new exploration and development wells and what would be considered infield drilling type programs, but they don't have information that there is going to be an increase in any of those individual segments. CO-CHAIR WIELECHOWSKI asked what level of increase they expect. How many years out does this information go? Is it public? Can he get a copy of it? COMMISSIONER GALVIN replied that it is part of the department's revenue forecast. CO-CHAIR WIELECHOWSKI asked what the projected increase is over the next five years without this credit. COMMISSIONER GALVIN replied the overall (capital) expenditure is expected to go up about 10 percent a year, but that would include things that don't qualify for these credits. CO-CHAIR MCGUIRE pointed out that if no investment is made no tax credit is given. It's a question of whether or not the state feels it's worthwhile to "partner in the risk." She said this committee has been looking at a number of tax credits and that she has heard from industry that ACES is broken. She thanked the governor for bringing stakeholders together to discuss how corporate behavior could be influenced in a way that would net a positive outcome for the state. 4:07:09 PM SENATOR HUGGINS said the commissioner listed the items based on a letter from the House asking for some adjustments, but there have to be some things that didn't make the cut. He asked if there is anything else he could share with the committee that might be "objective fixes." COMMISSIONER GALVIN replied that they looked at lowering the progressivity level from the current .4 percent or changing the kick off point. Some of the others were more technical, such as working with the definition of lease expenditures and the way the facility sharing costs are incurred or accounted for. 4:08:41 PM SENATOR HUGGINS said the item that intrigued him is the technique of "bracketing the progressivity." He asked if they looked at that. COMMISSIONER GALVIN replied that was looked at before the session; the other body had also proposed a similar methodology. Currently, if the production tax value per barrel goes over $30/barrel, the progressivity rate applies to the entire stream. The concept would be rather than applying the progressive rate to the entire stream to apply it to that portion of the stream above $30/barrel. If you just shear off the bottom $30 with prices where they are now, that amounts to dropping progressivity from .4 percent to .2 percent. It means at the higher end of the progressivity you'll be at a lower state take. In looking at the question of progressivity, the department always asked if it would result in more activity (investment, jobs and production). There seemed to be less connection between the benefit being provided by that change and the expectation of increased activity. So, they gravitated more to credits. 4:11:58 PM SENATOR HUGGINS asked if he thought the timing of these incentives would positively impact the big gas pipeline, particularly in the context of a successful instate gas pipeline and some petrochemical industry. COMMISSIONER GALVIN answered that he can see it in two different ways; for example, impacting those who are investing in exploration almost exclusively for gas in the Foothills right now. To the extent that the credits will provide incentives to them, that would be a positive. One of the limitations to the exploration incentive credit program is that the activity has to be a certain number of miles from an existing well, and given the seasonal nature of Alaska's drilling program, a producer might start drilling one year but have to wait to finish it the next year and would not get the same exploration credit for that pad. This measure would benefit that type of activity. Also, to the extent that a producer is looking to use these credits for additional infield drilling and that enhances their expectation of future gas production, it will decrease their perceived reservoir risk associated with a long-term commitment on a pipeline. To that extent it could have an incremental value. 4:14:51 PM SENATOR WAGONER asked how much development has to happen in a new field prior to this credit kicking in and being applicable to each well - for instance at Pt. Thomson. COMMISSIONER GALVIN replied basically none. Development is not directly defined as to an existing field or a developed field. It applies to "all wells." 4:15:28 PM SENATOR FRENCH asked if the oil industry supports this bill. COMMISSIONER GALVIN said he believes so. A number of new entrants spoke very positively with regard to access to the new credits and the cash back from the state. 4:16:31 PM SENATOR FRENCH remarked that he didn't see a lot of people in the audience. COMMISSIONER GALVIN responded that if he wanted to invite the industry to comment, he thought they would be here. CO-CHAIR WIELECHOWSKI asked if this bill passes, does it end the oil tax debate once and for all. COMMISSIONER GALVIN replied this is an attempt to address the concerns that have been raised, and from his perspective it will send a very positive message that the state is responsive to industry's concerns. But it is up to the legislature to decide. 4:17:44 PM SENATOR HUGGINS commented that North Dakota is booming and asked if the commissioner is familiar with what they are doing. COMMISSIONER GALVIN said he is not aware that they have any particular program in place and he suspects the boom is driven by the resource. Comparing Alaska with any of the Lower 48 states isn't really a fair comparison because they don't own the resource themselves and don't have the same levers available to them as Alaska does. Also their relationship to the industry isn't the same. SENATOR HUGGINS asked why Alberta is so "upside down." 4:19:37 PM COMMISSIONER GALVIN replied what he understands from Alberta is they had a couple things happen to them almost simultaneously to form a sort of overheating of the industry. The oil sands had a huge influx of activity, and in that time they significantly changed their fiscal system by creating tiers. If you come into it now it is different than a couple of years ago. Then when the oil prices came down, everything started to implode and their fiscal system looked out of place. Beyond that he hadn't spent a lot of time comparing their system to ours. CO-CHAIR MCGUIRE invited the commissioner to look at what other jurisdictions are doing with regard to taxes and tax credits over the Interim. 4:22:05 PM CO-CHAIR MCGUIRE closed public testimony and set the bill aside.