HOUSE FINANCE COMMITTEE February 8, 1996 1:37 P.M. TAPE HFC 96-29, Side 1, #000 - end. TAPE HFC 96-29, Side 2, #000 - end. TAPE HFC 96-30, Side 1, #000 - end. TAPE HFC 96-30, Side 2, #000 - 581. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 1:37 p.m. PRESENT Co-Chair Hanley Representative Martin Co-Chair Foster Representative Mulder Representative Brown Representative Navarre Representative Grussendorf Representative Parnell Representative Kelly Representative Therriault Representative Kohring ALSO PRESENT Representative Joe Green; Ken Boyd, Director, Division of Oil and Gas, Department of Natural Resources; Ed Behm, Occidental Oil and Gas Corporation (OXY) USA Inc.; Bruce Policky, Exploration Manager, BP Exploration (Alaska) Inc.; Charles Logsdon, Chief Petroleum Economist, Department of Revenue; Bill Vandyke, Petroleum Engineer. SUMMARY HB 325 An Act authorizing suspension of payment of a portion of the royalty due the state for initial production of heavy oil from wells on the Arctic Slope. HB 325 was HELD in Committee for further discussion. HOUSE BILL NO. 325 "An Act authorizing suspension of payment of a portion of the royalty due the state for initial production of heavy oil from wells on the Arctic Slope." REPRESENTATIVE JOE GREEN testified in support of HB 325. He stated that the intent of the legislation is to find a way 1 to make development of heavy oil on the North Slope economical. He estimated that between 25 and 40 billion barrels of heavy oil are entrapped. He noted that attempts to economically produce heavy oil have not been successful. He stressed that there are more reserves of heavy oil than existed in the original Prudhoe Bay discovery. He acknowledged that the heavy oil cannot be fully recovered. Heavy oil is thick, low gravity oil which is not in a consolidated reservoir. It moves up almost to the permafrost level. Heavy oil is almost as thick as molasses. Production problems are greater for heavy oil than for "normal" oil. The royalty holiday would provide a holiday or suspension from the royalty that would otherwise be paid to the State. He maintained that the royalty holiday would help operators over the economic hurdle in developing a profitable method of extraction. He asserted that it behooves the State to cooperate with developers. He stressed that operators are hopeful that operating costs per barrel can be reduced. He noted that wells drilled within 10 years would receive a holiday from the royalty for five years. After that time the normal royalty amount would resume. He compared HB 325 to HB 207. House Bill 207 was adopted and became effective on 6/30/95. He reiterated that under HB 325 royalties will be forgiven for five years. House Bill 207 allows the Commissioner of the Department of Natural Resources the discretion to forgive royalties. He emphasized that there are other areas of the world where heavy oil exists. He maintained that the State could miss opportunities to develop reserves of heavy oil if action is not taken. KEN BOYD, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES maintained that industry, the Legislature and the Administration want to see Alaska's oil and gas resources developed in an economically and environmentally sound matter. He pointed out that the State will not receive royalties for five years on wells drilled prior to July 1, 2006. He noted that wells drilled in the year 2006 will be royalty free until the year 2011. He asserted that there is no showing of need in HB 325. He emphasized that the same terms apply to all operators. The grant is automatic. He alleged that the terms of the bill were selected without any economic analysis. He questioned why a five year exemption, 500 barrels a day or a $15 dollar net back were chosen. He stressed that companies have given no assurance that fields would be drilled. He pointed out that companies can shut down wells or apply for a reduction under HB 207 at the end of five years. He maintained that HB 207 is the proper vehicle for developmental incentives because it requires an economic analysis. He stressed that fields can be transferred under HB 325. He acknowledged that HB 325 is more administratively difficult. He stated that he 2 would work with the Committee if modification to HB 207 is needed to specify that heavy oil is included. He reiterated that HB 207 would be the best vehicle. In response to a question by Representative Martin, Mr. Boyd stated that he did not understand why the terms in HB 325 are necessary or are the only terms necessary. He questioned if development is worth a zero royalty for five years. He stressed that other options may be identified with an economic analysis. Representative Navarre asked if Mr. Boyd has presented written arguments regarding HB 207. He noted Mr. Boyd's expertise. He stated that he supported, in general, trying to offer an incentive. He added that it is the Legislature's responsibility to assure that there is ample justification when dealing with the State's resources. Mr. Boyd referred to a letter he wrote to Representative Williams regarding the use of HB 207 for royalty relief for heavy oil. (The letter was provided to the Committee later in the meeting. See Attachment 3.) Co-Chair Hanley stated that it would be helpful to review the letter. He noted that questions have been raised by the Administration regarding the use of HB 325 for royalty relief. He asked that the letter as well as any other concerns or objections and points that need to raised be provided to the Committee in order to get the answers to the questions. Representative Brown agreed that some incentive is appropriate. She stated that the question is how the incentive should be tailored to assure that the State does not leave more on the table than is necessary. She stated that the heart of the matter is the debate between the Administration and the Legislature regarding royalty relief for a specific situation as opposed to an across the board suspension. Representative Brown referred to "An Opportunity to Develop Alaska's Heavy Oil Resources...," by British Petroleum (BP) Exploration and Occidental Oil and Gas Corporation (OXY) USA Inc., January 22, 1996 (copy on file). She quoted from page 25: "OXY seems the fairest candidate since, unlike other North Slope producers, OXY's revenues from Schrader Bluff production will come solely from wellhead revenues--OXY does not share in significant downstream pipeline, tanker or refinery profits." She asked if this analysis is accurate. Mr. Boyd stated that he does not have the data to back up their assumptions. She asked if the Department has asked to see underlying production and cost data or other data to have confidence that this is a reasonable starting point for consideration of an incentive. Mr Boyd stated that he has not requested the data. He noted that, even if data 3 supported the claim that the terms are reasonable for OXY, the terms would also apply for BP. He noted that CONOCO was not able to develop the Milne Point field absent a royalty reduction. The field was sold to BP. He noted that BP has increased production by 25 percent and will eventually increase production by 50 percent without royalty reduction. He stressed that one company's economics is different from another's. Representative Brown asked what advantage pipeline owners have over nonowners. WILLIAM VANDYKE, PETROLEUM ENGINEER, DEPARTMENT OF NATURAL RESOURCES responded to questions by Representative Brown. He stated that the estimated advantage of the majority owner is .50 cents to a dollar. Representative Brown asked how much difference the royalty rate makes in the face of price uncertainty. Mr. Boyd stated that for a project that is truly on the edge that a royalty reduction would be appropriate. Representative Brown referenced appendix A, page 4, in the report by OXY and BP. She noted that the report states that OXY cannot apply for royalty reduction for these specific leases. Mr. Boyd stated that HB 325 would override the agreement cited in appendix A. He suggested that language contained in HB 325 on page 1, line 6 stated that "Notwithstanding any other provision of this section or any provision in a lease, unit agreement, or other agreement between a lessee and the state that establishes an obligation to pay royalty on production..." would remove the prior obligation. Representative Brown asked how the provision would be interpreted under HB 207. Mr. Boyd stated that it would prohibit relief for the 9 percent share holder, OXY. The 91 percent share owner could apply for relief under HB 207. He stressed that BP, the 91 percent partner, could share royalty relief with their minority partner. Representative Brown asked how long it would take a company to go through the process outlined in HB 207. Mr. Boyd answered three to six months. He suggested that the process may move quicker if all the pieces were ready. Representative Mulder asked what the State stands to loose from HB 325. Mr. Boyd stated that $220.0 thousand dollars per well would be lost per year. The number of wells that would be drilled is unknown. He noted that the Department of Revenue has a fiscal note that accompanies the legislation. 4 Representative Green clarified that there was a royalty reduction at Milne Point. He added that Kuparuk is the major oil reservoir at Milne Point. The Kuparuk reservoir is not as viscous and shallow as the heavy oil addressed by HB 325. In referring to the Administration's preference for an economic analysis Representative Green maintained that a car buyer does not ask General Motors to show their balance sheets to see exactly what the car costs before they make their offer. He asserted that the operators have come forward with their "sticker price." He questioned if the State is willing to accept the loss of revenue to allow proof in the field through royalty free pilot projects. Representative Navarre asked the current oil head value. Mr. Boyd responded that the current oil head value is $10.0 dollars a barrel. House Bill 325 allows an exemption from payment of royalty to the portion of the value at the wellhead, net of eligible field cost deductions. Representative Navarre asked what the market value of the oil would have to be in order to net $15.0 dollars a barrel. He noted that the industry has stated that the price of oil is one of the biggest determining factors in assessing project feasibility. CHARLES LOGSDON, CHIEF PETROLEUM ECONOMIST, DEPARTMENT OF REVENUE stated that a net of $15.0 dollars would equate to a market price of $21.50 dollars a barrel for heavy oil in Milne Point. Representative Navarre asked the justification for the number and price per barrel used in HB 325. Representative Martin expressed frustration with testimony by the Administration. He summarized that the Administration does not see a value in the approach taken by HB 325. Mr. Boyd emphasized that the Administration does not know what the right terms are. Representative Martin questioned what the State needs to get the right answers. Mr Boyd responded that the economics of the company are needed. He questioned if the intent is to give BP and all other companies the same break as OXY. Representative Martin stated that "if it is a good resource to sell, and it would help the State with our economic problems, and they (oil companies) want to invest millions and millions and hundreds of millions to prove that it is worth something, please go get it." Mr. Boyd reminded Representative Martin that the resource would be royalty free. Representative Martin asked if the values used in HB 325 are 5 not fair then what does the State think is fair. Mr. Boyd responded that he did not know if the values are fair because he has not seen the back-up economics to show if it is fair or not. He added if it is fair "how can it be fair for every company." Co-Chair Hanley emphasized that "there needs to be a determination based on the facility or well or field on whether it is economic or not, based on some general criteria, rather than looking at the net profits of a company." Representative Brown responded to comments by Representative Green. She stressed that the exercise before the Committee is not like buying a car. She maintained that legislators act as trustees for the State's resources. She noted that the State is the land owner. She added that the operators have entered into contracts and agreed on contract terms to develop these resources. She observed that it has become apparent that those terms are not economic. She asserted that it is appropriate to look at the individual specifics of why the obligations agreed to cannot be fulfilled. (Tape Change, HFC 96-29, Side 2) Representative Brown questioned if a $15 dollar break is appropriate for OXY, how much more of a break is being given to other companies. She asked at what price, generally, economic development could occur in the heavy oil sands. Mr. Logsdon did not have a number available. He stressed that the State has only recently obtained development plans for the Schrader Bluff area. Representative Therriault summarized that a determination may be made based on a small operator's economics which may not apply to larger operators. He suggested that the legislation may be too broad. Representative Kelly observed that the State is worrying about the value of the customer as opposed to the value of the product. He stated that the legislation will provide an incentive for smaller producers. He spoke in support of absorbing some of the breaks given to larger companies in order to provide incentives to small producers. Mr. Boyd responded that HB 207 is an opportunity for companies of any size to apply for a royalty incentive. He stressed that the most important thing the State can do is to maintain a good lease sale program and get state lands into the hands of those that want to develop them on a regular basis. He maintained that the State has a good 6 lease sale program. He added that the State is trying to make the administrative and permitting process easier. Representative Navarre assessed that most members of the Committee are interested in offering necessary incentives. He noted that the question is what level incentives should take. He observed that the Economic Limit Factor (ELF) will reduce the production tax to at or near zero. A royalty holiday would limit the State's revenue to corporation tax. He stated that "I'm looking for what level of incentive you can offer and still generate the type of activity they want, without going to what might be perceived, at some point, as a windfall, if the price of oil is at the $15 dollar well head value and the wells come in at 495 barrels each." He estimated that at this rate of return the oil companies' profit would be significant. He pointed out that this revenue stream accrues to both the Permanent Fund and General Fund. He stated that he is willing to agree that HB 207 might not always work and that perhaps something else should be put in place. He stressed that justifications and restraints should be in place to make sure it is a win/win situation. In response to a question by Co-Chair Hanley, Mr. Boyd clarified that heavy oil production at Schrader Bluff is currently at 3,000 barrels a day. Mr. Logsdon observed that the state long range forecast includes an estimation for increased heavy oil production. Heavy oil production values in the fall forecast were based on estimations by BP that Schrader Bluff production will peak at 45,000 barrels a day by the year 2005. He stated that Schrader Bluff production would generate revenues to the State of approximately $20.0 to $25.0 million dollars a year at peak. In response to a question by Representative Martin, Mr. Boyd emphasized that he would welcome as many companies into Alaska as wish to come. He reiterated that HB 207 is available for any size company to make its case. Mr. Boyd acknowledged that heavy oil production should be encouraged. He added that the State should look at what is the right answer. He stated that "I don't think we make up numbers and say that is the right answer and apply it to everything." Representative Martin noted that the State has not offered other data. Mr. Boyd stressed that the data belongs to the oil companies. He did not specify what data needs to be available. He noted that the State would do an economic analysis under HB 207. ED BEHM, HEAVY OIL TEAM LEADER, OCCIDENTAL OIL AND GAS CORPORATION (OXY) USA INC. testified in support of HB 325. He noted that OXY produces approximately 60,000 barrels a day in their total U.S. operations. He pointed out that the 7 Milne Point Unit alone could produce 60 to 65 thousand barrels a day. Mr. Behm provided members with charts used during his testimony (Attachment 1). He noted that Milne Point is OXY's largest domestic capital project. He stated that OXY plans to spend $40 to $50 million dollars for capital growth in Alaska. He noted that the Schrader Development represents approximately half of the production potential in the Milne Point Unit. He stated that without royalty suspension the State anticipates revenues of $60.0 million dollars from Schrader Bluff production. He stressed that with royalty suspension the State could receive $425.0 million dollars through increased production. He observed that OXY produces oil from the Sag River reservoir which passes through the Schrader Bluff reservoir. Mr. Behm stated that heavy oil is low gravity, thick oil that produces slowly over a long period of time. Heavy Oil is generally defined as crude oil with an API gravity of 20 degrees or less. He emphasized that production of heavy oil is capital intensive. He observed that the federal government is also considering incentives for heavy oil production. Mr. Behm stressed that ARCO invested $135 million dollars in 13 wells and related facilities for heavy oil. He observed that ARCO spent $169 dollars a barrel in capital investment. Mr. Behm demonstrated that 300 barrels a day is an average production rate for a well drilling heavy oil. He stressed that a 500 barrel a day suspension is necessary to assure an average production rate of 300 barrels a day. He guessed that 25 or 27 wells are currently producing. He emphasized that since production began at Milne Point's Tract 14 the level has remained constant. Mr. Behm stated that OXY spent $126 million dollars on 22 wells with an average production rate of 275 barrels of oil per day. He summarized that OXY's total investment amounts to $9.30 dollars per barrel of oil. He suggested that production costs can be further reduced. Mr. Behm discussed the "hurdle rate" or minimum rate of return necessary to justify capital investment. He noted that the cost of capital, overhead, and risk must be accounted for before profit can begin. He observed that OXY's profit margin is 15 percent. Mr. Behm referred to a portion of a report compiled by Arthur D. Little Inc. contained in Attachment 1. He stressed that the report also concluded that 15 percent is the minimal profit margin. He stated that most projects do not exceed 35 percent. 8 Mr. Behm reviewed heavy oil well economics based on the 5 best wells to date in Tract 14. He noted that the rate of return was 12.8 percent. He summarized that this represents a loss of $300.0 thousand dollars a well. Mr. Behm concluded that HB 325 will offer an incentive to develop more wells. He observed that similar incentives are offered by other states. He maintained that incentives in Texas have resulted in a 400 percent increase in the number of wells drilled. He asserted that the additional economic value generated for Texas is $12.0 billion dollars. Mr. Behm asserted that the effect of royalty suspension on Schrader Bluff economics to OXY would be a net cash profit of $115.0 thousand dollars per well as opposed to a $307.0 thousand dollar loss per well without the suspension. He clarified that the rate of return is based on the State's spring forecast. Mr. Behm stated that it would take a company 10 years to recoup their capital investment in a heavy oil field. The State would receive royalties after 5 years. He stressed that there is no reason an oil company would walk away from a long term profitable resource. He pointed out that OXY's Alaska branch has a high reinvestment rate. Representative Brown asked if OXY is willing to provide data underlying costs and profitability levels to the Department of Natural Resources so that analysis can be confirmed. Mr. Behm replied that he would be willing to supply and discuss their data with the Department. He asserted that heavy oil projects need general incentives. He maintained that the values used in HB 325 represent a reasonable number to "jump start" these kinds of projects. He pointed out that HB 207 was designed to encourage marginal new projects. He acknowledged that Schrader Bluff produces 3,000 barrels of oil a day and is profitable. He emphasized that it is not profitable enough to expand production. Representative Brown noted that the State forgoes royalty in the short run for a long run gain. She asked how the State can assure that the long run gain will be realized. Mr. Behm stressed that once a well is drilled and makes a profit there is no reason to shut the well in. He added that well performance is a matter of public record. Representative Brown observed that a case could be presented in the future for more reductions. Mr. Behm reiterated that the problem is making a return to pay for the capital investment. He stated that the company would have to prove that they are at the economic limit for a HB 207 reduction. He stressed that Schrader Bluff wells are not at economic limit. They could not prove that the Schrader Bluff wells would have to be 9 shut in since they are profitable. He restated that it would not be profitable to drill new wells. Representative Brown noted that companies are granted rights for all the reservoirs in a unit. She asked why a particular reservoir should be segregated from other more profitable ones. Mr. Behm noted that companies are profit driven. (Tape Change, HFC 96-30, Side 1) Mr. Behm summarized that HB 325 will stimulate new wells. Representative Martin asked if the Division of Oil and Gas has been given data from OXY. Mr. Behm noted that the Department of Natural Resources has data on Tract 14 wells from royalty settlement negotiations. He asserted that the Department "would have the information if they wanted to look at it." Mr. Behm stressed that disagreement occurs over the speculation of future costs. Representative Mulder asked what new technologies are on the horizon that might make heavy oil more profitable to develop. Mr. Behm noted that steam drives at close spacing are used in California. He stressed that new technologies are often expensive. In response to a question by Representative Mulder, Mr. Behm stated that he would not foresee additional new wells for Schrader Bluff without the incentives. Representative Mulder observed that legislators are mandated to get the best deal possible. He asked how realistic are estimates of revenues the State will realize from heavy oil production after the five year holiday. Mr. Behm stated that "if things continue the way I would envision then that should be a logical outcome." In response to a question by Representative Navarre, Mr. Behm clarified that well production varies. New wells are not necessarily higher producers. Representative Navarre observed that ARCO's cost per barrel of oil was $169 dollars. OXY reduced their production cost to $9.30 dollars a barrel. He questioned how far technology has advanced in the last 10 years and asked how far will technology advance in the next 10 years in allowing for better economics for heavy oil development. He observed that any well drilled before the year 2006 would have the benefit of technology developed up to that time. He pointed out that the royalty incentive would allow a greater rate of return. Representative Navarre suggested that the State may 10 want to offer the royalty incentive for a five year period. The issue could be revisited in the year 2001 to see if it should be extended. Representative Navarre asked if a holiday based on a rate of return has been considered. Mr. Behm stated that a holiday based on the rate of return would triple administrative costs due to audit exercises. Representative Navarre asked what the rate of return would be with a $15 dollar well head value for a well producting 300 barrels a day. He asked what the capital cost recovery would be with the five year holiday. Mr. Behm could not respond, but agreed to provide data on the question. Representative Brown asked if existing wells can be modified for heavy oil production. Mr. Behm stated that some wells could be modified but that they would not receive the royalty incentive. He stated that it is not the intent, as he understands it, to allow modified wells to qualify. In response to a question by Representative Therriault, Mr. Behm stated that redrilling the same well would not be considered as a new well. He added that the well "is still called the same thing. It is only granted a five year holiday from initial investment." Representative Brown referred to page 2, line 2. Co-Chair Hanley noted that language in the legislation can be tightened to clarify the intent of the Committee. In response to a question by Representative Kelly, Mr. Behm explained that a 5 percent royalty discount rate would equate to a 5 year royalty suspension. He stressed that a 5 percent discount over the life of the well would result in a greater loss of revenues to the State. Representative Navarre asked the rate of return on existing wells after capital costs. He questioned if the 300 barrels per day average has improved in newer wells. Mr. Behm noted that the average is improving. He stated that the last 10 wells are closer to 400 barrels a day. He noted that his economics are based on a production level of 400 barrels a day. BRUCE POLICKY, EXPLORATION MANAGER, MILNE POINT, BRITISH PETROLEUM spoke in support of HB 325. He provided members with charts highlighting points of his overview (Attachment 2). He noted that the Milne Point Unit is the Northern most production unit on the North Slope. It is located between the Kuparuk and Prudhoe Bay units. British Petroleum Exploration purchased the unit in 1994. There are 11 approximately 26 billion barrels of heavy oil underlying existing North Slope units. He noted that not all of the oil is recoverable. The quality of the field varies. Page 3 of Attachment 2 shows Schrader Bluff Heavy Oil Development. He noted that Tract 14 development only represents approximately 1 percent of the total resource. He summarized that in 1991 21 wells were drilled. There was a high capital investment of $135 million dollars with a low initial production rate which averaged 275 barrels per day. He noted that new completion technology was tested. The wells remain on production. He emphasized that commercial development stopped in 1991. Mr. Policky stated that BP noticed after the unit was purchased that the unit was performing well without high well decline. A demonstration project was initiated by BP in 1994 and 1995. The objective of the program was to demonstrate that a commercial project in the heavy oil accumulation at Schrader Bluff could be economically feasible. They attempted to increase production rates and reduce development uncertainty. Fifteen million dollars were spent in 1995 to drill six new wells. Three older wells were recompleted. Drilling costs were reduced. Operating expenses remained high. Submersible pumps were used. Page 7 of Attachment 2 outlines technology used at Schrader Bluff. He noted that heat trace is used to keep wells from freezing. He observed that it costs $1.0 million dollars to complete a well. He emphasized that completion in other areas is only half as expensive. Mr. Policky discussed international competition for capital funding. He noted that there are more projects than funds available. He stressed that cost reductions and increased production are not enough to win funds without the addition of development incentives. He emphasized that the addition of development incentives will not guarantee that they will be successful in competing for developmental funds. He noted that the Department of Revenue's Fall Forecast presupposes that BP will be successful in competing for funds. Mr. Policky reiterated that there are approximately 2 billion barrels of heavy oil in place at Schrader Bluff. He estimated that 200 to 800 barrels could be recovered. He maintained that the royalty holiday will: * Reduce investment uncertainty; * Encourage investment; * Send a positive signal; and * Accelerate the pace and increase the scope of development. 12 Mr. Mr. Policky stressed that heavy oil fields have a long production life. He estimated that well production will last 41 years. He profiled production on 230 wells drilled over a nine year period. He estimated that 300 million barrels would be recovered. Only 30 percent of the produced oil would be royalty free. He stressed the importance of maintaining development momentum. He emphasized that anytime a project is deferred there is a potential for value loss. He stated that ultimate recovery could be placed at risk if the project is delayed. Representative Martin questioned what information the Department of Natural Resources would need from BP to be comfortable with the values used in HB 325. Mr. Policky stressed that the Schrader Bluff BP projects have not been completed, but offered to share information gathered. He restated that BP supports HB 325. He noted that BP has spent $17.0 million dollars for Schrader Bluff production. No more wells are budgeted. He stressed that heavy oil development does not compete for capital funds without additional incentives. He observed that new projects have to be approved by the London Board of Directors. All of BP's holdings compete for investment funds. In response to a question by Representative Therriault, Mr. Policky noted that BP is expanding handling capacity at their central facility from 30,000 to 65,000 barrels a day. He noted that the Kuparuk development will fill the facility. To make room for heavy oil production the central facility would have to be increased to 95,000 barrels of oil or more. He emphasized that heavy oil production would have to pay for the upgrade. Four or five new pads would be needed. Some existing pads could be utilized. (Tape Change, HFC 96-30, Side 1) Mr. Policky clarified that the difference between the rate of return needed by BP only differs a few percentage points from those needed by OXY. Representative Brown asked if BP would share information on a confidential basis. Mr. Policky stated that he thought that BP would share information with the Department of Natural Resources on a confidential basis. Representative Brown noted that OXY does not share downstream tanker, pipeline, or refinery profits. Mr. Policky stated that there is a minor financial benefit to the pipeline owner. Representative Brown restated testimony estimating that the benefit to BP through their pipeline ownership is between .50 cents and a dollar. Mr. Policky did not know the value of the benefit to BP through ownership of the pipeline. Representative Brown asked at what price development of 13 heavy oil would be economic for BP. Mr. Policky was unable to answer. He emphasized uncertainties. He guessed that the price would have to be 20 to 30 percent higher. He maintained that a net well head value of $15.00 dollars per barrel is reasonable. Representative Navarre asked the expected rate of return on BP's $15.0 million dollar investment. Mr. Policky stated that the rate of return is low. He emphasized that risk funds were incorporated. He observed that the wells are not on production. He stated that it costs between $1.6 to $2.0 million dollars to drill and complete a well. He added that surface facilities can run from $500.0 thousand dollars to $1.0 million dollars a well. Representative Brown referred to page 1, line 14. She asked the eligible field cost deductions for Milne Point. Mr. Policky responded that it is consistent with royalty calculations to determine well head values for royalty payments. In response to a question by Representative Therriault, Mr. Policky stated that production is limited at Milne Point by the capacity of the central facility to handle production. He noted that the well cost includes a flow line to a gathering point, gravel, flow lines to the central facility, and upgrades to the central facility. In response to a question by Representative Green, Representative Navarre clarified that he would like to know if the current rate of return is less than the 15 percent threshold identified as the minimum profit margin. He questioned what level of capital investment can be supported. He suggested that a credit could be given against a percentage of the capital investment to throw their economics over the 15 percent threshold. He questioned if the well head value is at $15.0 dollars today and the wells were producing at an average of 300 barrels a day would the rate of return be above the 15 percent threshold. Representative Green summarized that Representative Navarre is looking for a rate of return on the investment. Mr. Policky observed that if well head prices are high for heavy oil on the North Slope than they would be high for oil production throughout the world. He noted that the same capital allocations are in place for competition with other world projects. Representative Navarre concluded that higher incentives may need to be offered to win competition for Alaska. Representative Brown asked if projections by the Department 14 of Revenue are accurate. Mr. Policky stated that the projections are accurate if the project is approved. He cautioned that the project has not been submitted for approval. He stressed that there is no guarantee that the project will be approved. He did not foresee development of the project without adoption of the incentives in the near future. He emphasized that all parties encounter a degree of risk. Representative Brown asked the Division of Oil and Gas to take advantage of a willingness by the operators to share additional information. She asked the Department to look over the assumptions used in HB 325 based on the access of information available. Mr. Boyd maintained that the data available to the Department is six years old. He stated that he needs to know what to do with the data. He stressed that he could work under HB 207 applications. Co-Chair Hanley summarized that the Administration is opposed to HB 325. He asked for the Administration's opposition in writing. He noted that members were provided with a letter from Mr. Boyd to Representative Williams, dated 1/30/96 (Attachment 3). He requested that any comments, criticisms or reasons opposing HB 325 be provided as soon as possible in writing to allow a response from industry. Representative Brown asked the Department to complete an analysis of the assumptions in HB 325 as if it were applied to the mandates of HB 207 to determine if it is a reasonable incentive. She asserted that the Division of Oil and Gas has the necessary expertise and that industry representatives have stated that the data is available. Co-Chair Hanley summarized Representative Brown's question. He concluded that the question is: Is an incentive necessary to develop heavy oil based on economics? He observed that if an incentive is necessary the Committee can continue to debate the form it would take. Representative Navarre noted that it would be helpful to ascertain what type of incentive would be granted if the field were applied to HB 207. He asked the Department's suggestions for protecting the State's interest if HB 325 is adopted. Mr. Boyd referred to Attachment 3. Co-Chair Hanley added that the Committee needs a written response from the industry summarizing why HB 207 does not work. He requested that any additional concerns, comments, or questions by Mr. 15 Boyd be prepared by 2/13/96. Mr. Boyd responded that he will comply with the request. He suggested that discussion occur regarding what data is necessary to make a determination. Co-Chair Hanley reiterated that the Administration believes that HB 207 is the appropriate vehicle. Mr. Boyd stated that HB 207 is the mandate the Department was given under law. Co-Chair Hanley pointed out that the Legislature makes decisions on law. He questioned if HB 207 handles all the situations that the Legislature is trying to address. He asked Mr. Boyd to make suggestions for modification of HB 207 or other options if HB 207 will not handle heavy oil incentives. Representative Martin expressed concern that the legislation not be delayed. Co-Chair Hanley assure him of the Committee's intention to take action. Representative Brown restated her request to have a party outside of the operators to provide an analysis of the legislation. Representative Navarre observed that information is needed to make a competent decision. He pointed out that an asset of the State is being discussed. Mr. Behm maintained that data is available. He stressed that HB 325 creates an advantage for companies to come to the State of Alaska to develop heavy oil. Representative Navarre expressed concern that the legislation projects fifteen years. He observed that technology has advanced in the last 10 years. He stressed that advances in the next 10 years will change overall economics. ADJOURNMENT The meeting adjourned at 4:15 p.m. 16