HOUSE SPECIAL COMMITTEE ON OIL & GAS February 11, 1993 5:00 p.m. MEMBERS PRESENT Representative Joe Green, Chairman Representative Pete Kott, Vice Chairman Representative Harley Olberg Representative Gary Davis Representative Jerry Mackie MEMBERS ABSENT Representative Jerry Sanders Representative Joe Sitton COMMITTEE CALENDAR Overview from Legal Department WITNESS REGISTER James Baldwin, Assistant Attorney General General Civil Section Department of Law P.O. Box 110300 Juneau, Alaska 99811-0300 465-3600 POSITION STATEMENT: Gave an overview of the Department Charles E. Cole, Attorney General Department of Law P.O. Box 110300 Juneau, Alaska 99811-0300 465-3600 POSITION STATEMENT: Provided information about the Department Bruce Botelho, Deputy Attorney General Department of Law P.O. Box 110300 Juneau, Alaska 99811-0300 465-3600 POSITION STATEMENT: Discussed tax categories ACTION NARRATIVE Tape 93-5, Side A Number 000 CHAIRMAN JOE GREEN called the House Special Committee on Oil and Gas to order at 5:06 p.m. Members present at the call to order were Representatives Green, Kott, Olberg, Davis, and Mackie. He welcomed everyone to the meeting and noted the meeting was being teleconferenced. He commented that James Baldwin from the Department of Law was present to give an overview. JAMES BALDWIN, ASSISTANT ATTORNEY GENERAL, DEPARTMENT OF LAW, introduced Attorney General Charles E. Cole who gave a brief overview of the Department. CHARLES E. COLE, ATTORNEY GENERAL, stated when Governor Hickel first came to Juneau the relationship between the Department of Revenue (DOR) and the Department of Law (the Department) was not what the Governor had in mind. He went on to explain that he and Commissioner Rexwinkel of the DOR addressed that issue and made good changes. He spoke about the royalty litigation, which went on for a number of years and was largely resolved. Through this, the Department had developed massive information about oil transactions which, he stated, was responsible for more than $600 million. He said that out-of-state lawyers were retained for different cases who brought different views for some major issues. MR. COLE advised that the Department took a very close look at those cases and then met with the taxpayer. Before any negotiations were entered into they arrived at a figure by unanimity and if everyone on the settlement team did not agree then they went back and worked on the problem again until everyone agreed. These meetings were held professionally, courteously, and in good faith, and oftentimes were requested by the taxpayer, he said, and believed it was very important, at the conclusion of negotiations, that all parties could sit down and laugh and talk. Number 256 CHAIRMAN JOE GREEN asked if a final agreement was also a unanimity requirement within the Department. Number 269 MR. COLE said unanimity prevailed throughout the entire process, right down to the final signatures. Number 280 CHAIRMAN GREEN inquired into the process by which settlement was reached. Number 294 MR. COLE responded,"Its magic. It is an art form. After 40 years of doing this you get an idea of what works and what doesn't. We talk, debate the issues, and are very well prepared." Number 319 CHAIRMAN GREEN asked why the Department went to outside counsel. Number 330 MR. COLE stated attorney fees were not a large factor in using outside counsel. Number 332 CHAIRMAN GREEN asked, "It was not like a one-third percent or anything like that?" Number 334 MR. COLE replied in the negative. He stated there were some exotic issues in one case, and outside counsel had been obtained to test their evaluation of the issues, for assurance that the state's analysis was correct and they were on the right track. He stated $300,000 was an accurate figure for the cost of outside counsel in that case. Number 364 REPRESENTATIVE HARLEY OLBERG asked if the $300,000 was in addition to the amortization of the $50 million. Number 365 MR. COLE thought that had been recovered in the royalty cases. Number 382 CHAIRMAN GREEN asked if there was a possibility they might be establishing a precedent in subsequent years. Number 392 MR. COLE replied in the negative, because each case was different. The sense he got from speaking with the taxpayers was that they wanted to address the issues. Number 403 REPRESENTATIVE OLBERG stated he read in BP's press release that the settlement amount would not have a significant effect on their year-end results because they had already accounted for it. He inquired whether BP had prepared for this type of a result. Number 408 MR. COLE said it was BP's contention that it would not make a material difference in their tax statement, although they did not say how much had been reserved for settlement. He then asked to be excused. Number 415 CHAIRMAN GREEN introduced James Baldwin and Bruce Botelho. Number 421 MR BALDWIN gave a brief overview of the operations of the Department. He explained the BP settlement was an income tax case that involved questions of law, which could be handled in a cost effective manner. For the upcoming fiscal year he stated the Department would spend approximately $25 million to finance various areas of litigation, of which approximately $18-19 million would be used to finance the cost of outside counsel and experts. MR. BALDWIN explained further the types of litigation being handled were oil and gas tax, that being the severance or production tax. In this area there were approximately $1 billion in outstanding appeals. Number 472 CHAIRMAN GREEN asked if the $1 billion included the recent settlement. MR. BALDWIN reiterated the $1 billion was pending appeals. He advised of the category known as "income and excise cases," which covered the recent BP case. He clarified the $1 billion was for oil and gas severance, which was a different kind of tax. He added there was another category of cases known as "royalty cases." Number 480 BRUCE BOTELHO, DEPUTY ATTORNEY GENERAL, stated another category was separate accounting, which encompassed the tax years 1978 through 1981, and would also be in the $1 billion plus range. Three tax categories included the production or severance tax, a separate accounting income tax, and the worldwide combination that went by a number of names, which was the issue in the recent BP settlement, he disclosed. Number 487 CHAIRMAN GREEN asked what separate accounting was and how it varied. Number 495 MR. BALDWIN said he would be glad to speak with any of the committee members individually. Number 500 MR. BOTELHO explained that separate accounting attempted to put a fence around the state of Alaska, in that it was an income generated solely and separately accounted for activities of an oil and gas corporation in the state as opposed to how income might be assessed looking at a worldwide operation, which was really the worldwide combination. It was a constitutional challenge to the accounting income tax brought by the entire industry. The Legislature was concerned about the constitutionality and that the state would have to refund the billions that were being generated by separate accounting. This led to enactment of special legislation for the oil and gas industry, the worldwide combination approach, which was what the state relied on in addition to the severance tax, for its income, he concluded. MR. BOTELHO noted Greg Erickson was in the audience. Number 519 MR. BALDWIN explained what Attorney General Cole stated about the major settlement of the royalty-in-value part of the case was not quite correct. This was known as the Amerada Hess Case, which had been going on since the 1970's, he said. In November, 1991, there was a major settlement in the amount of $633 million, which provided a methodology for fixing the value of the state's royalty oil. That settlement included everything that happened from 1977 to sometime in 1992, he added. MR. BALDWIN alleged the settlement had the effect of setting the price of the state's royalty oil into the future and, therefore, had monumental significance in terms of the state's revenue picture. What remains to be litigated was how much the state should pay producers for cleaning and conditioning natural gas liquids produced as part of the oil flow of the North Slope fields, he disclosed. MR. BALDWIN advised that another aspect of royalty cases was the royalty-in-kind disputes, which concerned the state's entitlement to a retroactive price adjustment on existing royalty oil contracts. These contracts carried clauses that tied the value of the oil to the outcome of the Amerada Hess value settlement. The total value of those settlements was approximately $300 million, he noted. MR. BALDWIN disclosed settlements had recently been concluded with Petro Star for approximately $2 million, and Tesoro for approximately $94 million. The state was currently in litigation with Chevron and multiple litigation with MAPCO, he added. Number 575 MR. BOTELHO interjected that the state by royalty and statute was entitled to one-eighth of everything that came out of the ground either in-value or in-kind. Number 611 MR. BALDWIN said there were potential claims of $327 million, of which approximately $99 million had been resolved and $47 million had been paid under protest. This left a balance of $181 million in outstanding claims against royalty-in-kind purchasers. He said his department planned to spend approximately $6 million pursuing those claims and that he did not see an inexpensive way out of this type of litigation. Number 619 CHAIRMAN GREEN understood that at times the state would be suing a company and also be a partner with that company in another lawsuit against a different company. Number 624 MR. BALDWIN said, "It is a lawyer's dream and a taxpayer's nightmare." He went into the Tesoro settlement and stated that they structured settlement so Tesoro could continue operating. One of the ways this was done was to take over their rights to claim against another purchaser of the oil, he explained. Tape 93-5, Side B Number 000 MR. BALDWIN spoke about the Federal Energy Regulatory Commission. He explained that as a seller of oil the state must be watchful of the pipeline's tariffs. This activity was undertaken in Washington D.C., and attorneys from Washington, D.C. were hired and interfaced with attorneys in the state. The value of oil was determined by netting-out, among other things, the price of transporting that oil in order to get maximum dollars into the state treasury, he disclosed. MR. BALDWIN noted that Endicott Pipeline had been settled recently. In that instance, a tariff had been instituted some years ago, the state protested, and settled with the carrier at a lower rate. Because of this, the state was now entitled to additional tax and royalty. "We basically watchdog the carriers and their filings," he said. MR. BALDWIN spoke on the Trans Alaska Pipeline Service (TAPS) settlement and stated that when it was entered into years ago it was worth an initial payment of $250 million in refunds. He directed members to his handout, and stated that continued monitoring of filings occurred. Through that monitoring activity, the upcoming effect of the new filing had been recently reported to the legislature, he said. The total for the calendar year would be an approximate $80 million increase in revenues because of a change in the tariff structure, he added. Number 105 MR. BOTELHO talked about corrosion on the pipeline and noted that prudent costs were not imposed or included as part of the tariff rate base. He pointed out the lawyers had first determined the corrosion problem and continued to work with the TAPS owners, as well as Aleyska Pipeline Service Company cooperatively, to ensure a pipeline corrosion correction plan was in place. Number 131 MR. BALDWIN stated that in the upcoming fiscal year they would spend $1.5 to $2 million on monitoring activities. A major part of this was hiring an expert to do a corrosion monitoring program as part of the alternate dispute resolution process currently engaged in with the pipeline carrier. He talked about oil and gas litigation, including entitlement to land underlying the Beaufort Sea. This case had significant revenue implications for the state, however, the extent of potential to be realized from it was unclear, he noted. MR. BALDWIN advised the state was engaged in litigation, and had been for quite some, time with a well financed and serious adversary in the form of the federal government. There was an escrow fund, which would be a potential source of recovery for the state, of over $1 billion. A Special Master's decision was forthcoming, and everyone expected the case to go to the U.S. Supreme Court, he alleged, with an expected cost of approximately $500,000 for the next fiscal year. Litigation was also pending out of the district attorney's Anchorage office, dealing with the oil export ban, he added, and pointed out that case had both in-house and outside counsel. Number 200 CHAIRMAN GREEN asked if there was an act in legislation that would help. MR. BALDWIN advised that the Congressional Delegation had historically attempted to have the ban lifted. There was hope in the Bush Administration that an executive order might have been issued that would arguably give some authorization for export of crude oil itself. The Department of Law's efforts were aimed solely at challenging the underlying authority of the executive branch of the federal government to impose the ban, he said. "We have one claim in the US Court of Claims in Washington D.C., but we do not feel we have a very good chance of pursuing it there," he added. Number 234 CHAIRMAN GREEN inquired into the length of the Department's presentation. Number 241 MR. BALDWIN directed the committee to the handout, which related to the Department's budget. Number 268 CHAIRMAN GREEN commented that the handout was impressive. He stated that many of the committee members were new to the process and would come to Mr. Baldwin with questions. Number 283 MR. BOTELHO stated at times outside counsel were brought in to explain specific cases and, if the committee desired, they could also address the committee. ADJOURNMENT Number 310 CHAIRMAN GREEN stated for the record that Jeff Logan and a representative from Exxon were at the legislative information office in Anchorage. He thanked everyone for coming, and adjourned the meeting at 6:07 p.m.