HOUSE FINANCE COMMITTEE April 30, 1996 8:15 A.M. TAPE HFC 96-148, Side 1, #000 - end. TAPE HFC 96-148, Side 2, #000 - end. TAPE HFC 96-149, Side 1, #000 - #414. CALL TO ORDER Co-Chair Mark Hanley called the House Finance Committee meeting to order at 8:15 a.m. PRESENT Co-Chair Foster Representative Martin Representative Brown Representative Mulder Representative Grussendorf Representative Navarre Representative Kelly Representative Parnell Representative Kohring Representative Therriault Co-Chair Hanley was absent from the meeting. ALSO PRESENT Representative Ramona Barnes; John Shively, Commissioner, Department of Natural Resources; Robin Randall, Fairbanks; Al Near, Fairbanks. SUMMARY HB 548 An Act authorizing, approving, and ratifying the amendment of Northstar Unit oil and gas leases between the State of Alaska and BP Exploration (Alaska) Inc.; and providing for an effective date. The Work Session on HB 548 was recessed until transmittal of the legislation. SB 112 An Act establishing a discovery royalty credit for the lessees of state land drilling exploratory wells and making the first discovery of oil or gas in commercial quantities. SB 112 was rescheduled to another time. SB 289 An Act relating to runaway minors and their families or legal custodians. 1 SB 289 was HELD in Committee for further consideration. SENATE BILL NO. 289 "An Act relating to runaway minors and their families or legal custodians." ROBIN RANDALL, FAIRBANKS testified via the teleconference network. She expressed concern that the legislation remain strong. She read a letter to the Committee (copy on file). She emphasized that children run away from good homes. She maintained that getting tough and attaching consequences to running away is effective. AL NEAR, FAIRBANKS testified via the teleconference network. He maintained that the House Judiciary Committee version has weakened the legislation. He stressed that the legislation is not about abused, homeless or neglected children that voluntary walk into youth shelters. He asserted that the legislation is about the growing number of rebellious teenagers that exploit weakness in the existing laws to manipulate to the system to evade authority. He stressed that the revolving door policy must be ended. He spoke in support of the Senate version of SB 289. He emphasized the need for early intervention. SB 289 was HELD in Committee for further consideration. HOUSE BILL NO. 548 "An Act authorizing, approving, and ratifying the amendment of Northstar Unit oil and gas leases between the State of Alaska and BP Exploration (Alaska) Inc.; and providing for an effective date." Co-Chair Hanley noted that the Committee would conduct a work session on HB 548. JOHN SHIVELY, COMMISSIONER, DEPARTMENT OF NATURAL RESOURCES gave an overview of the Northstar oil field. He noted that Northstar is offshore of the North Slope. There are seven leases; five state leases and two federal leases. Four leases were released in 1979. The bid variable was the net profit rate. A base rate of 20 percent was set and the oil companies bid how much of their profits they would share. The average net profit bid was approximately 89 percent. The fifth lease was bid in 1983 and had a set net profit of 40 percent with a bonus bid of $72.0 thousand dollars and a 12.5 percent royalty. Commissioner Shively noted that in 1979, most people were 2 estimating that oil prices would continue to rise at the astronomical rates of the 1970's. The leases were awarded to a consortium of companies headed by Amerada Hess. The field is estimated to produce 130 million barrels of oil. Original projections were approximately twice this amount. Commissioner Shively observed that a Department of Energy study concluded that the field was uneconomic due to the net profits provision. Amerada Hess came to the conclusion that they could not economic develop the field. Development costs are estimated at $1.5 billion dollars. The leases were offered for sale. The leases were won by British Petroleum Exploration (Alaska), Inc. (BP) in 1995. The State agreed to the transfer and allowed BP three years to look at a development plan. Commissioner Shively stressed that net profit share is a fairly complicated way to due business. Oil companies make expenditures, pay themselves back, and then start to pay the State. This is complicated by a development account. He explained that as oil companies begin to spend funds, expenses are accrued into the Development Account. The Developmental Accounts run with the leases not with the company that spent the money. When BP bought the leases they also received a $200 million dollar Development Account. The Account is currently at $262 million dollars. The greater the account and the longer it takes to pay it off, the less the net profits are worth. He observed that the question is whether or not there is enough money to pay off the Development Account so that the State can get to their net profits. This is driven by volume, price and the amount of money that has gone into the Development Account. Commissioner Shively stated that the Department of Natural Resources does not think Northstar is a marginal oil field. He estimated that BP could make a 20 percent rate of return. In return for giving up the net profits the State would get a supplemental royalty, based on price adjusted for inflation. This would earn the State 7.5 percent above the base 20 percent royalty. In addition, BP agreed to raise the 12.5 percent royalty to 20 percent. This field would have the highest royalty in the North Slope. The State also received a promise from BP to get the project sanctioned by their Board of Directors or return the leases to the State. Commissioner Shively pointed out that BP is in the middle of a three year development plan. He did not think that the State could take the leases back until after the three year period. The State could order BP into production in the end of April 1998. At this time, BP could give the leases back, begin production or sue the State. 3 Commissioner Shively stressed that BP is committed to build modules for the project in Alaska. He noted that they had previously indicated that the modules would be build in Canada. Commissioner Shively explained that 1996 dollars and the State's mid case scenario were used to assess value. He estimated that the State would receive $37 million dollars in supplemental royalty. If the field were developed under net profit share today the State would receive $85 million dollars. He emphasized that it is unlikely that BP would develop the field before 1998. If the project were developed in 1998 the net profit share would drop from $85 to $41 million dollars. The longer it takes for a field to develop the less the net profits. He pointed out that more oil in the pipeline reduces the tariff for existing oil. Northstar would be the first off shore development in the North Slope. Northstar development will be on an island with a buried pipeline. Commissioner Shively observed that the Department of Natural Resources submitted a fiscal note for the State Pipeline Coordinator's Office. Commissioner Shively noted that BP thinks it can bring the cost of the project down to $350 million dollars. He pointed out that an additional $25.0 million dollars in expenses would wipe out the net profits. Commissioner Shively stated that the legislation needs legislative approval. He maintained that there should be public review. In response to a question by Representative Mulder, Commissioner Shively stressed that it is to BP's advantage to wait to develop the field. He maintained that a volume of 130 million barrels is a reasonable amount. Representative Mulder noted the value of BP's agreement to give up the lease if the project is not sanctioned. Representative Brown questioned why the solution does not incorporate other fields. Commissioner Shively stated that Northstar is a relatively unique situation. He maintained that it is a situation that can be dealt with on its own. He stressed that it would be difficult to find a generic fix for net profit leases. He acknowledged that there are other net profit share and bid variable leases. Representative Brown questioned the precedent of HB 548 in relation to other leases. Commissioner Shively emphasized that it is the responsibility of the State to look at the development 4 of its resources. He noted that other aspects of leases have been changed. He maintained that the legislature would have to approve any changes to net profit leases. Representative Brown pointed out that the State has never changed a competitively bid lease outside the statutory frame work. She noted that the legislature is not permitted to violate the Constitution. In response to a question by Representative Martin, Commissioner Shively clarified that the total net profit of the field if it were developed in 1998 or 1999 would be $41 million dollars. The State would receive over $400 million dollars with the addition of royalty. The life of the field is estimated at 12 years. Commissioner Shively noted that the Department of Natural Resources estimates that without the legislation development would begin around the year 2002. REPRESENTATIVE RAMONA BARNES spoke in support of HB 548. She stressed that the legislation will bring the production on line earlier than the year 2002. She stressed that the purpose of HB 548 is to bring revenues to the State and assure local hire. She maintained that CSHB 548 (WTR) would provide for local hire without weakening the constitutionality of the bill. She observed that CSHB 548 (WTR) reflects a lease agreement that was voluntarily signed by the Commissioner of Department of Natural Resources and Mr. Luttrell, Vice President, British Petroleum Exploration. (Tape Change, HFC 96-148, Side 2) Representative Barnes discussed CSHB 548 (WTR). She noted that the complete text of the lease agreement was incorporated into the legislation beginning on page 5. She maintained that the legislation meets the constitutional test because of the voluntary agreement. She noted that the agreement demands that BP file reports every 6 months to demonstrate how they have complied with the local hire provisions. Representative Barnes referred to the fiscal note accompanying CSHB 548 (WTR). A letter from John C. Morgan, President, BP, was attached (copy on file). She noted that the legislative findings in HB 548 are extensive. Representative Martin expressed concern that BP may need outside expertise. Representative Barnes emphasized that the legislation will create a module industry in Alaska that can be exported. She maintained that it is in Alaska's best 5 interest to try to provide jobs for its people and make sure jobs are not just entry level. She noted that the legislation does not require that every job be held by an Alaskan. She asserted that Alaskans can be trained. Alaskan residency is detailed in the bill. Representative Grussendorf questioned if the legislation allows individuals or groups to challenge the lease. Representative Barnes noted that anyone can sue anyone at anytime. She asserted that the separation of powers doctrine is followed in the bill. Representative Navarre pointed out that there are already trained unemployed Alaskans that can be put to work. Representative Brown asked if there is any recourse if the terms of local hire and module production do not take place. Representative Barnes stressed that BP would suffer from a bad public image if they do not live up to the intent of the legislation. She maintained that the State could introduce sanctions against BP. Representative Brown asked for a explanation of language on page 6, lines 8 - 10: "In determining feasibility, lessee shall consider commercial, health, safety, and environmental conditions and requirements" in determining feasibility. Representative Barnes stated that "commercial" means that Alaska has in place a system to build the modules. Representative Brown referred to a memorandum from John Miller, Attorney to Bill Allen, VECO Corporation, dated April 4, 1996 (copy on file). Mr. Miller concluded that any requirement for BP to adopt a resident hire policy or procedure would constitute impermissible State action. Mr. Miller added that: "If it could be shown that the State of Alaska exercised coercive power or provided significant encouragement, either overt or covert, BPXA's actions would be deemed to be that of the State." Mr. Miller concluded that the local hire provisions would be struck down. Representative Barnes noted that the opinion was given to Mr. Jack Chenoweth, Legislative Counsel. Mr Chenoweth responded to Mr. Miller's statements in a memorandum, dated April 29, 1996. Representative Barnes asserted that there was no coercion in any way. Representative Brown stressed that there is significant encouragement that local hire be part of the proposal. Representative Barnes reiterated that, in exchange for giving up the net profit share, BP voluntarily agreed to the local hire provision. She referred to a memorandum by James Baldwin, Assistant Attorney General, dated March 26, 1996 6 (copy on file). She noted that Mr. Baldwin maintained that the State must show public benefit for giving up the net profit share. She emphasized that public benefit is established through the lease document which institutes local hire and module building in Alaska, and allows for an early production date. Representative Brown agreed that local hire is a significant part of the proposal. She maintained that the inclusion of local hire would open the legislation to a constitutional challenge. Representative Barnes disagreed. Representative Brown maintained that the State required the local provision to be part of the proposal. Representative Barnes maintained that the House World Trade Committee record reflects that BP voluntarily reached the agreement to give up something for something. Representative Mulder supported Representative Barnes' claims that BP did submit to the terms voluntarily. Discussions continued regarding the proposal. Representative Brown reiterated concerns regarding the constitutionality of the proposal. Commissioner Shively gave a brief history of the proposal. He noted that BP approached the State and asked that net profit shares leases be included in HB 207. The Administration decided that HB 207 was not the appropriate vehicle. He felt that there was not legal authority for him to make an agreement. He indicated that legislative approval would be needed. He observed that there were discussions about the issue of local hire and constitutionality throughout the negotiations. Representative Brown questioned the lost value to the State if other net profit oil leases were modified. Commissioner Shively stated that each lease has different conditions. He clarified that there have not be discussions regarding other net profit leases. There are approximately 40 net share leases, with 9 that are producing. He reviewed other net profit leases. Representative Mulder questioned if it would be in the financial interest for other net profit leases to make a modification to a 20 percent base royalty. Commissioner Shively did not have any statistics regarding the proposed change. He did not think it would be advantageous to change other net profit leases. In response to a question by Representative Navarre, Commissioner Shively noted that the Superior Court ruled that the Development Account could be transferred. He 7 thought that the Court would consider the legislative record. He noted that the Legislature has included intent language. He pointed out that the law is the legislative effort. Representative Martin expressed concern that the contract is outside of the legislation. Commissioner Shively responded that the State can encourage but not require BP to institute local hire. He observed that BP's voluntary agreement made the legislation acceptable to the Legislature. He emphasized that the main issue is how the State encourages a company to institute local hire. He stressed that BP has been made aware of how important local hire is to the political leadership, Administration and Legislature. He noted that BP initially proposed to build the modules in Canada. Representative Martin questioned if there are enough unemployed people in the state of Alaska to fill the jobs that would be created. Commissioner Shively pointed out that many of the best jobs available are in the oil industry. Representative Martin stressed that it is easy for oil companies to bring in their own people. He questioned if union contracts need to be changed. Commissioner Shively noted that unions have local chapters. (Tape Change, HFC 96-149, Side 1) In response to a question by Representative Kelly, Commissioner Shively explained that Kuupik is a non- producing unit. Most of the leases are net profit share. He stressed that there is not enough oil for production. The State has never received any money for the Duck Island net profit share leases. Representative Therriault observed that net profit leases were only issued from 1980 - 1984. He noted that testimony in 1979, argued that net profit share leases were uneconomical for the State. Commissioner Shively clarified that lower oil prices are not conducive to net profit share leases. He stressed that the Oil and Gas Policy Council has suggested that the State may want to take more risks in order to encourage development. He noted that a more traditional system of sharing risks or a profit proxy could be used. In response to a question by Representative Therriault, Commissioner Shively reviewed supplemental royalty. He noted that royalty is based on a per barrel price of $17.35 dollars. Anything above $17.35 dollars a barrel, ANS West coast, would result in an increase in supplemental royalty. The price is adjusted for half of the inflation factor on an 8 annual bases. The escalator begins April 1996. Commissioner Shively noted that the State would currently receive an additional 7.5 percent, if the agreement was active. Representative Brown pointed out that 4 of the 5 leases already have a 20 percent base royalty. The fifth lease that was raised from 12.5 to 20 percent has no production allocated to it. She questioned if the conditions in AS 38.05.180(j) were considered. Commissioner Shively explained that State tried to get the same information from BP that would have been required in a application for reduction under HB 207. The Department did not go through the 16 step process contained in HB 207. He stressed that there was no legislative authority to use this process for decision making. He noted that HB 207 was designed to look at marginal oil fields. The commissioner must declare that the royalty reduction is necessary for the development. He observed that a finding that a royalty is necessary to make Northstar economically viable could not be found. He reiterated that Northstar is not a marginal oil field. He stressed that the timing of development is of concern to the State. He observed that there is a question as to whether net profit share can be considered a royalty. He emphasized that he testified that HB 207 did not apply to net profit share leases. In response to a question by Representative Brown, Commissioner Shively noted that no outside contractors were hired to assess the hydrocarbon potential production. He stressed that the Department was confident that the in house, economic model was accurate. He emphasized that the public record has been made in the legislature. In response to a question by Representative Brown, Commissioner Shively stated that the process in HB 207 is onerous. He pointed out that HB 207 was changed from a three to sixteen step process. He observed that there is no final legislative approval in HB 207. He maintained that if there were not legislative approval for the proposal under discussion that the Department's process would have been more extensive. He maintained that the Department's decision is getting full public review. Representative Brown asked if the Department conducted an oil price sensitivity analysis to compare net profit share capturing of up side and down side economics versus supplemental royalty. Commissioner Shively stated that there is no net profit share on the down side. Representative Brown provided members with charts showing 9 the effect of up side and down side prices (copy on file). She observed that if oil prices are 10 percent higher than the State's base case assumes there is a significant benefit from the use of net profit share. She concluded that the State is giving up a significant part of the up side. She agreed that supplemental royalty protects the State on the down side. Commissioner Shively pointed out that even a small increase in expenses eliminates the net profit share. He reiterated that timing is a problem. He felt that the State's mid case oil scenario is aggressive. He concluded that the certainty of the supplemental royalty was worth the trade offs. Representative Brown asked the effect of a lawsuit on the State. Commissioner Shively observed that if a lawsuit was lost and the proposal returned to a net profit share, there would be a further delay of any net profit benefit. He stressed that the effect is worse on the net profit share leases because of the accumulation of the Development Account. He stated that the longer the delay the better the supplemental royalty. He noted that if there was a delay to the year 2003, the supplemental royalty goes to $80.0 million dollars, and the net profit share falls to under $20.0 million dollars. By 2005 the net profit share would be zero. Representative Therriault referred to the fiscal note. He observed that the House Department of Natural Resources Subcommittee determined that the Agency's budget would not be cut to accommodate the legislation. The fiscal note would fund the legislation. HB 548 was HELD in Committee for further consideration. ADJOURNMENT The meeting adjourned at 10:05 a.m. 10