HOUSE FINANCE COMMITTEE March 22, 1996 1:40 P.M. TAPE HFC 96-85, Side 1, #000 - end. TAPE HFC 96-85, Side 2, #000 - end. TAPE HFC 96-86, Side 1, #000 - #142. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 1:40 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.; Bill Vandyke, Petroleum Engineer; Jon Tillinghast, Attorney, Occidental Oil and Gas Corporation (OXY) USA Inc. 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. CSHB 325 (FIN) was reported out of Committee with "no recommendation" and with a fiscal impact note by the Department of Revenue and with a fiscal impact note by the Department of Natural Resources, dated 1/24/96. 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." 1 REPRESENTATIVE JOE GREEN testified in support of HB 325. He provided members with Amendment 1, 9-LS112\R.7 (Attachment 1). Co-Chair Foster MOVED to adopt Amendment 1. Representative Green observed that Amendment 1 is the result of a work session with the Division of Oil and Gas and operators. KEN BOYD, DIRECTOR, DIVISION OF OIL AND GAS, DEPARTMENT OF NATURAL RESOURCES provided members with a memorandum summarizing Amendment 1 (Attachment 2). He noted that the amendment clarifies the meaning of a "well". He pointed out that the memorandum contains suggestions for amendments to the legislation: Amendment 2 (E) for purposes of calculating the first 500 barrels per day of production from a well, production from dual completions and other forms of multiple completions in a well is to be added together and counted as production from a single well. Amendment 3 (f) for purposes of defining fieled costs in this subparagraph, field costs include the costs outlined in AS 38.05.180(f). Co-Chair Hanley noted that the memorandum from Mr. Boyd, includes other amendments to the legislation: Amendment 4 Page 2, line 10 delete "finished goods" insert "industrial commodities" Amendment 5 Page 2, line 22 insert after "performed" "at least once monthly" Mr. Boyd discussed the substantive changes contained in Amendment 1. He stated that the Amendment 1 clarifies what a well is and what a well is not by inserting "for purposes of this subparagraph, `actual initial drilling' does not include plug-backs of existing wells, sidetracks from existing wells, multi-lateral or dual completions of existing wells, or sidetracks of redrilled wells,". 2 Mr. Boyd identified other substantive changes made by Amendment 1: Page 2, line 30 (2) by taking an exemption from the payment of royalty under this subsection, the lessee waives any right that the lessee might otherwise have under its lease, unit agreement, or other agreement with the State to deduct, against royalty due the State, any field costs associated with the production of the heavy oil for which exemption is taken; and (3) in this subsection `heavy oil' means oil having a weighted average equal to or less than 20 degrees API gravity as the term API gravity' is defined in AS 43.55.900. Mr. Boyd stressed that the remainder of the amendment provides for renumbering. JON TILLINGHAST, ATTORNEY, OCCIDENTAL OIL AND GAS CORPORATION (OXY) USA INC. discussed Amendment 1. He agreed that the majority of the amendment renumbers sections. He observed that Amendment 1 clarifies that the exemption only applies to new wells and not to the redrilling of existing wells. Mr. Tillinghast observed that Amendment 1 clarifies that the $15 dollar a barrel ceiling will be the "lessee's reported royalty before any field cost deduction." Mr. Tillinghast noted that the last substantive change made by the amendment clarifies that any heavy oil field costs that royalty is not paid on cannot be deducted against other production. Mr. Tillinghast discussed amendments suggested by Mr. Boyd in Attachment 2. He observed that Amendment 2, with the addition of subsection (e), would clarify that the suspension would pertain to the total production of individual pipes of a multiple completion well. He noted that Amendment 3 would amend AS 38.05.180(f) to define field costs. Amendment 4 by Mr. Boyd would make more accurate reference to what it is that the producer price index reports. He did not object to the first three amendments. Amendment 5 would change the requirement for gravity tests from quarterly to monthly. Mr. Tillinghast expressed concern with this requirement. He noted that the burden of 3 this amendment would be significant. He concluded that a quarterly gravity test would be sufficient. Mr. Boyd noted that flow tests are performed monthly. He did not think the requirement to perform gravity tests monthly would be onerous. In response to a question by Representative Martin, Mr. Tillinghast agreed that flow rates are continuously monitored. He pointed out that API gravity tests are not part of the existing testing and measuring system. BRUCE POLICKY, EXPLORATION MANAGER, MILNE POINT, BRITISH PETROLEUM explained that API gravity tests are performed in a lab. Samples are removed manually from the well and taken to a lab. He emphasized that this is labor intensive. The labs are on site. WILLIAM VANDYKE, PETROLEUM ENGINEER, DEPARTMENT OF NATURAL RESOURCES stressed that marginal wells could change on a monthly basis. He observed that other tests such as royalty accounting and production accounting are done monthly. Representative Green pointed out that the other tests mentioned by Mr. Vandyke are metered and performed in the field. He pointed out that API gravity tests would be more costly. There being NO OBJECTION, Amendment 1 was adopted. Representative Brown discussed Amendment 3. She noted that "field costs" are not defined in AS 38.05.180(f). Mr. Boyd maintained that for the purpose of defining "field costs" subsection (f) should be included in the legislation. Discussion ensued regarding the wording of the amendment. Mr. Tillinghast pointed out that AS 38.05.180(f) defines lease or unit expenses. He suggested that the amendment be amended to insert "those lease or unit expenses" and delete "the costs". Representative Brown noted that the amendment would clarify that these kinds of things are included. Representative Therriault MOVED to adopt Amendment 2. (E) for purposes of calculating the first 500 barrels per day of production from a well, production from dual completions and other forms of multiple completions in a well is to be added together and counted as production from a single well. There being NO OBJECTION, it was so ordered. Representative Therriault MOVED to adopt Amendment 3 as 4 amended. (f) for purposes of defining filed costs in this subparagraph, field costs include those lease or unit expenses outlined in AS 38.05.180(f). There being NO OBJECTION, it was so ordered. Representative Brown MOVED to adopt Amendment 4. Page 2, line 10 delete "finished goods" insert "industrial commodities" There being NO OBJECTION, it was so ordered. Co-Chair Hanley asked the expense of Amendment 5. Mr. Policky stated that an API gravity test would cost $50 dollars a sample. The labor involved in obtaining the sample would increase the cost. Mr. Boyd suggested that monthly API gravity tests be required for wells with a weighted average of 19 degree API gravity or greater. Representative Martin spoke in support of frequent sampling. Representative Therriault MOVED to conceptually adopt Amendment 5 to require monthly testing for wells having a weighted average of 19 degrees API gravity or greater, and to require quarterly tests on wells below 19 degrees API. There being NO OBJECTION, it was so ordered. Representative Brown referred to Attachment 2. She noted that Mr. Boyd suggested that "reported royalty" be changed to "actual royalty". Mr. VanDyke noted that adjusted royalty reports are filed after the initial filing. He stressed that if royalty adjustments push royalty over the trigger point that royalty will be paid. He noted that revisions are common. Members discussed the wording for proposed Amendment 6. Representative Brown asked if "adjusted" should be inserted. Representative Brown MOVED to adopt Amendment 6: Conceptually amend Amendment 1, page 1, line 14, after "royalty" insert "as may be adjusted." There being NO OBJECTION, it was so ordered. Representative Brown provided members with Amendment 7, 9- LS1122\R.5 (copy on file). Representative Brown MOVED to adopt Amendment 7. Representative Mulder OBJECTED for 5 purposes of discussion. Representative Brown stated that there should be some period of time when the State is guaranteed to get its base royalty. The amendment would prevent a lessee from claiming or obtaining an additional royalty adjustment on heavy oil production for 20 years after an exemption is taken under the bill. Mr. Tillinghast stressed that the Legislature is directly setting state royalty policy through the enactment of HB 325. He stated that the amendment is consistent with this approach. Representative Navarre expressed concern that advances in technology will result in greater savings to operators than estimated. He noted that testimony showed a third of the State's royalty will be forgiven under existing technology. He stressed that if technology is enhanced the State will give away a significantly larger percentage of its royalty share. (Tape Change, HFC 96-85, Side 2) Representative Navarre concluded that using assumptions provided by OXY that the operator will receive $1.177 billion dollars over five years from their investment. (172 wells X 300 barrels X $12.5 dollars per barrel X 365 days X 5 years.) He stressed that this would provide a 100 percent return on their capital investment, plus interest, and $600 million dollars in field costs for the forty year life of the field. He maintained that all the incentives are given on the front end. He asserted that there will not be incentive for additional investment in the wells to increase production after the royalty holiday. He stated that operators could receive $2.3 billion dollars based on 172 wells X 500 barrels X $15 dollars per barrel X 365 days X 5 years. He reiterated that there is a disincentive for development after the first five years of a well. Representative Green noted that if production is over 500 barrels a day royalty would be paid. He stated that the purpose of this provision is to assure that the State benefits from advances in technology. Representative Navarre clarified that royalty would only be paid on the incremental amount above 500 barrels a day. He asked what is the break even point in OXY's profit margin. He stressed the need to find a fair rate of return to provide an incentive for development while protecting the State's interest. Representative Green emphasized that royalty would only be forgiven on 10 percent of the available resource. 6 Representative Navarre pointed out that OXY's presentation used a 300 barrel a day average for their base economic assumptions. He observed that the bill allows a production average of 500 barrels a day. He suggested a field average of 300 barrels a day for all wells. Mr. Tillinghast disagreed with calculations by Representative Navarre regarding profit margins. He stressed that there will not be 172 producing wells in the first year. He stated that there will only be 15 producing wells in the first year and 30 producing wells in the second year. He acknowledged that the State runs some risk in lost revenues. He pointed out that the alternative is to take no action and lose the resource. He maintained that a brief royalty suspension minimizes the risk. He stressed that if a reduced royalty was granted over the life of the field that the risk would be for the full forty year field life. Representative Navarre argued that his calculations are not in error. He stressed that all 172 producing wells will have 5 years of royalty holiday, regardless of when they are drilled. He stated that he would support royalty reductions to allow returns of 100 percent of the operator's investment, interest and field costs. He emphasized that the legislation provides the potential for greater profits. Representative Brown stressed that the intent of Amendment 7 is to guarantee that the State receives the base royalty amount estimated by OXY. Representative Navarre questioned if an average well production rate on a field wide basis would be an acceptable compromise. Representative Green stressed that the rate would only apply to the well seeking reduction. He emphasized that higher gravity wells would not be included in the calculations. Representative Brown spoke in support of Amendment 7. She maintained that the amendment is needed to ensure that the promised benefits materialize over the life of the agreement. She emphasized the need to guarantee that operators do not receive additional reductions immediately after the expiration of the royalty holiday. Representative Navarre expressed concern that wells will be shut in if additional investment is required after the holiday expires. He concluded that operators could request additional reductions from the Legislature. Representative Navarre WITHDREW his objection to Amendment 7 7. Co-Chair Foster OBJECTED. A roll call vote was taken on the MOTION to adopt Amendment 7. IN FAVOR: Brown, Grussendorf, Navarre, Kelly, Kohring, Parnell, Therriault, Hanley OPPOSED: Mulder, Martin, Foster The MOTION PASSED (8-3). Representative Brown noted that BP and OXY had agreed to supply the Division of Oil and Gas with information supporting their assumptions. She questioned if this material had been delivered and reviewed. Mr. Boyd noted that the Division received some data from OXY two weeks ago. No information was received from BP. He observed that the Division's results differ slightly in some instances. He maintained that assumptions for OXY should not be applied for BP. Mr. Policky stated that BP has 85 percent of the data collected. He stated that BP would submit their data in the next week. In response to a question by Representative Brown, Mr. Boyd noted that the legislation would apply to a number of fields, including Kuparak, Endicott, West Sak and Prudhoe Bay. Mr. Tillinghast noted that heavy oil production in Prudhoe Bay would be under the same provisions as Milne Point heavy oil production. If a new well is drilled under the heavy oil provision the royalty holiday would apply. Representative Green noted that the heavy oil formation in Prudhoe Bay is surrounded by water. The ability to confine production to heavy oil will take a technological breakthrough. Representative Brown restated that the language on page 2, lines 13 and 14 only pertains to new wells. Mr. Tillinghast agreed that the legislation only applies to new wells. Representative Navarre questioned the policy that the legislation will implement. He asserted that a greater rate of return on the first five years of the royalty holiday does not mean that it will be reinvested into the life of the field. He maintained that the legislation almost guarantees that reinvestment will not occur. He suggested that royalties could be forgiven at one third of the well's value for the life of the well. He alleged that the legislation creates an incentive to shut in 8 wells. He asked if a royalty reduction on an annual basis was considered. Representative Green replied that if all wells were drilled instantaneously there might be some justification for Representative Navarre's suggestions. He emphasized that wells are not drilled all at one time. He stressed that the same capital is reinvested into additional wells. He maintained that heavy oil production is a high risk venture. He noted that two attempts have been made at production of heavy oil. He pointed out that operators cannot leave it up to speculation that the Commissioner will allow a royalty reduction after the infrastructure has been developed. There has to be security for development to occur. Representative Brown stressed that the level of royalty reduction needed to stimulate production has not been determined. She suggested that the legislation be held until data is available to determine the level of reduction needed. She added that amendments to HB 207 should be considered to allow the Commissioner to grant reductions on heavy oil pools. Co-Chair Foster MOVED to report CSHB 325 (FIN) out of Committee with individual recommendations and with the accompanying fiscal notes. Representative Navarre OBJECTED. He pointed out that the economic assumptions are based on the field's 8 percent owner, OXY. He suggested that economics for the 92 percent operator will differ. He noted that he would like to amend CSHB 325 (FIN); on page 2, line 1, delete "500" and insert "300". On page 2, line 14, delete "2206" and insert "2002". Co-Chair Foster WITHDREW his motion. Representative Navarre MOVED to on page 2, line 1 to delete "500" and insert "400". The amendment would provide that the royalty holiday be given on the first 400 barrels of daily production of heavy oil. Co-Chair Foster OBJECTED. Representative Navarre maintained that 500 barrels a day would provide an excessive profit margin. Mr. Tillinghast stated that OXY's assumptions were based on a 430 barrels a day production level. He stressed that 500 barrels a day provides for an average of 430 barrels a day. He maintained that the project would be sub-economic at 400 barrels a day. Representative Navarre argued that testimony stated that production rates for wells drilled at a later date are higher. Mr. Tillinghast argued against the amendment. He stressed that 500 barrels a day only just allows OXY to be competitive. A roll call vote was taken on the MOTION. 9 IN FAVOR: Brown, Grussendorf, Navarre, Hanley OPPOSED: Kelly, Kohring, Martin, Mulder, Parnell, Foster Representative Therriault was absent from the vote. The MOTION FAILED (4-6). Representative Navarre MOVED to delete "2206" and insert "2002" on page 2, line 14. He emphasized that the amendment would anticipate a more accelerated rate in terms of development. Mr. Tillinghast observed that BP's development plan expands nine years. He observed that later wells in the development plan would be shut out of taking advantage of the suspension. He noted that development is evaluated based on the rate of return of the whole project. He maintained that the rate of return for the whole project would be reduced. He stressed that disincentive for later wells would be created. Representative Navarre suggested that development would have to occur quicker. He acknowledged that the amendment may require a small amount of additional risk in terms of the capital investment. He maintained that the return would be just as great. (Tape Change, HFC 96-86, Side 1) Representative Navarre noted that the Legislature could revisit the issue prior to the sunset. He maintained that the amendment would require that the issue be revisited when more data is available. A roll call vote was taken on the MOTION to delete "2006" and insert "2002". IN FAVOR: Brown, Grussendorf, Navarre OPPOSED: Kelly, Kohring, Martin, Mulder, Parnell, Therriault, Hanley The MOTION FAILED (4-6). Co-Chair Foster was absent from the vote. Representative Mulder MOVED to report CSHB (FIN) out of Committee with individual recommendations and with the accompanying fiscal notes. Representative Navarre OBJECTED. A roll call vote was taken on the MOTION. 10 IN FAVOR: Kelly, Kohring, Martin, Mulder, Parnell, Foster, Hanley OPPOSED: Brown, Grussendorf, Navarre, Therriault The MOTION PASSED (7-4). CSHB 325 (FIN) was reported out of Committee with "no recommendation" and with a fiscal impact note by the Department of Revenue and with a fiscal impact note by the Department of Natural Resources, dated 1/24/96. ADJOURNMENT The meeting adjourned at 3:30 p.m. 11