HOUSE SPECIAL COMMITTEE ON OIL AND GAS March 7, 1995 11:12 a.m. MEMBERS PRESENT Representative Norman Rokeberg, Chairman Representative Scott Ogan, Vice-Chair Representative Gary Davis Representative Tom Brice Representative Bettye Davis Representative David Finkelstein MEMBERS ABSENT Representative Bill Williams COMMITTEE CALENDAR Committee work session with questions and answers on Oil and Gas royalties by the Department of Law, and the Department of Natural Resources. WITNESS REGISTER PATRICK COUGHLIN, Assistant Attorney General Oil, Gas, and Mining Section Department of Law 1031 West 4th Avenue Anchorage, AK 99501 Telephone: (907) 269-5255 BILL VAN DYKE, Petroleum Manager Division of Oil and Gas Department of Natural Resources 3601 C street, Suite 1380 Anchorage, AK 99501 Telephone: (907) 762-2550 ACTION NARRATIVE TAPE 95-7, SIDE A Number 000 CHAIRMAN NORMAN ROKEBERG called the House Special Committee on Oil and Gas to order at 11:12 a.m. The members present at the call to order were Representative(s) Rokeberg, Ogan and Brice. Chairman Rokeberg stated that today's meeting would be a work session. Number 015 CHAIRMAN ROKEBERG informed committee members there were two people from the Administration to give testimony. Chairman Rokeberg asked if they would identify themselves for the record. The gentlemen introduced themselves. BILL VAN DYKE, Petroleum Manager, Division of Oil and Gas, Department of Natural Resources, stated his responsibilities included unitization, permitting, and royalty administration. PATRICK COUGHLIN, Assistant Attorney General, Oil, Gas, and Mining Section, Department of Law, said his primary client agent is the Division of Oil and Gas. Number 030 CHAIRMAN ROKEBERG informed the members their objective for the meeting was to review HB 207 which is the Governor's royalty reduction bill, and to raise questions for the commencement of the hearings. Chairman Rokeberg stated this would be an informal meeting, and proceeded to begin the discussion. The bill will be introduced by Commissioner Shively on Thursday. Number 056 CHAIRMAN ROKEBERG began the discussion by mentioning Section 1 of the bill, which refers to the "hold harmless" provision of the permanent fund which restricts the 25 or 50 percent depending on the ages of the leases, in doing so it sets a floor under the reduction of what royalties can be reduced to; number one and number two provides income for the permanent fund in such a manner that, for example, on a 12.5 percent royalty if you were at a 50 percent lease you could only go down to 6.25 percent. If the commissioner then decided to lower the rate to 8 percent, the yield would then be only 1.7 percent to the general fund, and 6.25 percent to the permanent fund if that were the circumstance. The Chair had some concern for this because of our great need for income in the state. He then asked Mr. Coughlin and Mr. Van Dyke if they could provide some insight into this issue. Number 088 MR. COUGHLIN said one of the principles that the Governor wanted to see in regards to the bill was that the permanent fund would be "held harmless," consequently, the bill was drafted so the amount of royalties which would otherwise be paid to the permanent fund would continue to be paid. This was basically how the provision came into the bill. Mr. Coughlin said, I understand, if there was not a provision to make this payment to the permanent fund then there would have been some constitutional problem we would have been forced to address. Number 108 CHAIRMAN ROKEBERG stated as he understands it, the Attorney General thinks there may be some constitutional problems if Section 1 is deleted. He asked if this was correct. MR. COUGHLIN stated it was indeed correct. Number 111 REPRESENTATIVE TOM BRICE then asked if the royalty goes down, would the share which goes to the permanent fund go down. Number 115 CHAIRMAN ROKEBERG responded by stating the permanent fund would receive the same share of the 25-50 as it does now. Right now the statute creates an artificial floor. He said, "By this, I mean that you can not go below that level of funding." This may not be the best way to go about solving this problem. Chairman Rokeberg then stated he would like to move on. Number 137 MR. VAN DYKE stated at this point there is a provision for the existing exploration incentive credits that are available to companies, and when they cash in those credits, the permanent fund gets paid and then they take their credit against the general fund. This is not as explicit as this bill is. Number 150 CHAIRMAN ROKEBERG mentioned we should look at this and see what kind of relationship there is. He asked, in what instances does this have a relationship with the severance tax? Chairman Rokeberg said, for example, in the Cook Inlet, many of the wells have a position under the ELF where there is a zero severance tax, but they are still paying 12.5 percent royalty. But then there may be other fields which have an existing severance tax in place albeit reduced on this numeric order. Therefore, I would be curious to know if there is any statistical interplay in the total package. Number 165 MR. VAN DYKE stated there is some interplay. He mentioned the tax payments would go up a little as the royalties went down. Number 170 CHAIRMAN ROKEBERG informed the committee of some new information that was given to the committee members before the meeting. The handout to the committee was the "International Oil Tax Comparison Study" which was prepared by Aberdeen University, and Gaffney Cline Associates. He then asked Mr. Van Dyke if a model is available for us to use, or if we have run any numbers on this topic. Number 190 MR. VAN DYKE answered he was not sure if that model has been preserved in its entirety, but there are models available. He explained he has worked with staff from the Department of Revenue when the study was done. CHAIRMAN ROKEBERG then asked if the study has been updated due to the new changes that have taken place in recent years in the model itself. MR. VAN DYKE responded that there are models being housed in the Department of Revenue, and he would check on their public availability. CHAIRMAN ROKEBERG suggested he might check with Mr. Logsdon as well. Number 207 CHAIRMAN ROKEBERG then moved on, and mentioned there was some unclear language on page 2, Section 2. Chairman Rokeberg mentioned he was not sure if the language covers old fields and new fields. He explained the Section in question was on lines 28-31. Number 215 MR. COUGHLIN stated the new language beginning on line 28 is to cover, what I would call a "new field," meaning a field that has not gone into production whereas the previous statute covered fields which had been producing. Number 225 CHAIRMAN ROKEBERG asked if the distinction was that Section J covered old existing fields, and not new fields. He was answered in the affirmative. CHAIRMAN ROKEBERG asked if by redrafting this, would they be excluding old fields? Number 228 MR. COUGHLIN said their intent was to give a greater amount of flexibility to the commissioner so he could grant relief in a wider range of circumstances. Number 235 CHAIRMAN ROKEBERG suggested there should be the word "and" inserted on line 29 to make the language clear. Number 237 MR. COUGHLIN said he calls these things "trigger events." Previously, there have been two trigger events. The first allowed the commissioner in his discretion to grant relief to prolong the economic life of a field. The second, where you see the word "or" on line 31 allowed the commissioner to re-establish commercial production from a field. He stated they have added a third prong which allows the commissioner in his discretion to grant royalty relief to a shut-in field that has not gone into production at all. Number 248 CHAIRMAN ROKEBERG asked if the language provides for existing fields. MR. COUGHLIN said the Chairman was correct. CHAIRMAN ROKEBERG asked if "or" is a disjunctive word. Number 253 MR. COUGHLIN said the word "or" is from the previous version of the statute, and has not changed. Before you could do this to prolong the economic life of a field, "or" to re-establish commercial production of a shut-in field. He stated, now you can do this for those two, "or" a field which has not been previously produced. Number 257 CHAIRMAN ROKEBERG stated, now we have existing producing fields, shut-in fields, and new fields? MR. COUGHLIN stated he was correct. CHAIRMAN ROKEBERG explained he wanted to clarify that aspect of the bill to make sure it would impact some of the older fields in the state, for example the Cook Inlet fields. Number 270 MR. COUGHLIN asked the Chairman if he could address this issue for a moment. He said this was the specific purpose of the second prong which was to prolong the economic life of an existing producing field as costs increase and production decreases in the later stages of the fields life. Number 280 CHAIRMAN ROKEBERG said one of the areas of controversy which has arisen is the disclosure of confidential financial and technical data. He stated there were certain levels of comfort within the industry about this issue. Chairman Rokeberg asked if it was correct that the bill provides for a third party analysis of those records. He also asked how this would work -- would it be done by contract basis. Number 290 MR. VAN DYKE stated if a third party evaluation was going to be completed it would be done by contract, with an appropriate level of confidentiality agreement as part of the contract. Number 294 CHAIRMAN ROKEBERG said one of the concerns people have expressed is the provision in the bill which provides the Commissioner of Natural Resources almost absolute discretion in a type of black box environment. He stated he has had some discussions where the topic has been trying to open up that discretion. For example, could we have a kind of triad decision making process with the Commissioner of Revenue and the Attorney General. He asked what problems would arise with a system like this? Number 305 REPRESENTATIVE BRICE stated he understood what the Chairman was trying to get at. He then said, they do however trust the Attorney General to handle all oil settlements without oversight. Number 311 CHAIRMAN ROKEBERG stated the question is, how can we put a collar around the commissioner. Number 312 REPRESENTATIVE BRICE asked, to make sure that he doesn't give the farm away? Number 313 CHAIRMAN ROKEBERG said, exactly! How do we fence in that decision, this I think is the primary job of the legislature, so we will want to look at mechanisms which would have that effect. Among those, the Chairman stated, he remembered reading the Conoco request from Milne Point for reduction, there was stipulated an establishment of enumerated criteria which the commissioner could work with. Chairman Rokeberg asked if they would be prepared to talk about this issue in the future rather than just leave this matter to the discretion of the commissioner. The reason for this is there are no other stipulations other than oil prices that hold the commissioner in check. Number 331 MR. COUGHLIN stated the bill could be changed to add collars if they wanted to, but there is more than complete discretion here. The commissioner must make a finding that one of the three trigger events exists, and that finding would have to be based on the information presented by the companies before the commissioner could even consider whether to grant royalties. Number 340 CHAIRMAN ROKEBERG asked if there are existing regulations in place now that provide the best finding process which you have to follow, or do the additional regulations have to be bill created? Number 343 MR. VAN DYKE stated there are no stipulated measures or hurdles which would have to be met in the regulation right now. CHAIRMAN ROKEBERG asked if they would have to draft regulations if the bill was based as it is? Number 347 MR. COUGHLIN said they would not have to. Number 348 CHAIRMAN ROKEBERG stated it is for this reason we must fiddle with the proposed legislation. Number 351 MR. COUGHLIN noted there are a number of provisions in 38.05.180 where the commissioner makes a decision based on an analysis. This is not the only place where this appears. For example, we have a royalty reduction provision which allows the commissioner to reduce royalties for coal. The standard in this case is simply whenever a reduction is necessary to serve the public interest, he can grant one. Number 362 MR. VAN DYKE said two of the prongs have to do with either re-establishing production from a shut-in field or prolonging the life of a currently producing field. In those two cases, there is a fair amount of public information on the table already. People know what the rates are and what facilities have been constructed. The new prong will certainly have less public information available due to the fact it is a new field that has not begun production. He stated the best interest finding would be a public document. Number 374 MR. COUGHLIN asked if he could address this topic for a moment. He said, for example, in Conoco, there were two versions of the decisional document. There was a confidential version and a nonconfidential version. The confidential version did in fact keep confidential the information which Conoco had requested. Number 378 CHAIRMAN ROKEBERG stated this decision was a denial. If this was an approval, it would still be a confidential document? Number 387 MR. COUGHLIN said the way this was drafted, it is up to the company whether they want to keep the information confidential or not. Typically the statutes now require us to keep technical data confidential and we do keep financial data confidential at the request of the company for obvious competitive reasons. He then stated they would only keep it confidential upon the request of the lessee. Number 394 CHAIRMAN ROKEBERG stated he has been presented with an idea to gain some additional oversight over the Commissioner of Natural Resources. It was suggested that the Alaska Oil & Gas Conservation Commission (AOGCC) become involved as part of the whole loop which provides some oversight. He said he would like to receive some input from the Administration. He added, the process would work by letting the commissioner make his decision, and rather than it being the final determination, they should send the finding to the AOGCC and have them review it and either accept, reject, or return if for further analysis. This would seemingly provide some additional oversight to the singular discretion of one commissioner. He said he would like the Attorney General's Office to comment on whether putting the commission in the loop won't help to insulate the process from action by third parties. This is beneficial because the AOGCC is used to working with confidential materials, and are accustomed to that process. This may even increase the comfort zone of the commissioner himself. Number 426 MR. VAN DYKE mentioned there is a royalty board, but stated the board does not generally see the detailed information that comes along with an application. Number 427 CHAIRMAN ROKEBERG asked if the conservation commission works for the commissioner, and stated this could be a problem if it did. The Chairman was told it was an independent board. Chairman Rokeberg then asked if they served at the pleasure of the Governor, or if they can only be removed for cause. He was told that the board does not serve at the pleasure of the Governor. Chairman Rokeberg mentioned there was no sunset provision in this law. He stated one of the concerns which has been brought up about not having it, is that if there were a sunset provision it may appear as if the bill is being passed for specific members of the industry. In other words, if there is a tight sunset on this legislation, it may look like a setup job for specific projects. I do not think this is the case of this bill from the Governor, and it certainly isn't going to be the case of this committee. Number 446 REPRESENTATIVE BRICE said he thinks not having a sunset clause will provide a certain level of stability to the industry. They won't have to worry about having to fight for this legislation every two or three years. Number 448 CHAIRMAN ROKEBERG said he thinks the committee should discuss this because he looks at this as a collar on the commissioner. He then stated this also puts the legislature back into the loop. Chairman Rokeberg asked if there should be a re-evaluation every five years, or should they index the formulas we come up with. He said Representative Joe Green will be working with the committee in his capacity as Chairman of the House Resources Committee. He then stated Representative Green has some formulaic questions which he would like to work on. Chairman Rokeberg commented he noticed the legislation calls for adjustment based on oil prices, but there doesn't seem to be anything in the bill speaking to the fact that we may have stumbled upon a mini-elephant. He said a firm would pray for relief because it is a marginal field. Many times we really don't know until the area is not only delineated, and the reservoir is defined; it can turn out to be a better prospect than originally thought. Therefore, I think there should be at least narrative stipulation if not a formulaic stipulation to cover that occurrence, and we would like some help on that. CHAIRMAN ROKEBERG then stated there are obviously a lot of variables in any kind of consideration like this, and we might want to talk to the Department of Revenue about making sure all of these variables are covered adequately in the legislation. Chairman Rokeberg mentioned he would like to hear some arguments for or against net profits, and also payout processes. He said he likes the payout structure, but when you have a smaller field, by the time you pay it out there may not be anything left for the state. When you lower the royalty up front under a bell curve style of formula, which seems to make a lot of sense, because lowering the royalty at the beginning it helps the company recover their capital cost, then it can go up for a higher adjustment on a sliding scale for the state to recover there and then gradually go down as the productivity of the field goes down to help the firm maintain the field. This is another problem with the PFD floor, if you have a bell curve formula and there is a floor at 6.25 percent, for example, the Badami field has a variable royalty which is between 13.25 percent and 14.5 percent. Number 498 MR. COUGHLIN said there are some leases with 12.5 percent rates and some with 16 2/3 percent. He then said he believes the overall effective rate on a combined basis is slightly under 14 percent. Number 501 MR. VAN DYKE stated each lease is specific, it is either 16 2/3 percent or 12.5 percent. He then stated some are old leases and some are new leases. Number 509 CHAIRMAN ROKEBERG then asked if the field is unitized. Both Mr. Coughlin and Mr. Van Dyke stated it was not unitized yet. CHAIRMAN ROKEBERG then stated he would like to discuss delineated fields. He asked if there was anything in statute that defined delineation, and is there a need because of this statute to define delineation. Number 519 REPRESENTATIVE BRICE mentioned the committee was at a very good position to start the discussion. Number 523 CHAIRMAN ROKEBERG suggested to the committee that they read the August 1994 Gaffney Cline executive summary, the AOGCC summary, and the Division of Natural Resources rejection of the Conoco application for royalty reduction. MR. VAN DYKE handed out maps to the members of the committee. Number 534 CHAIRMAN ROKEBERG reminded the committee members they had copies of the existing statutes relating to this discussion. At this time Chairman Rokeberg asked the members of the committee if they had any questions they would like to ask. Number 543 REPRESENTATIVE DAVID FINKELSTEIN stated he had a couple of questions. He mentioned the permanent fund section of the statute, and stated it was easier for him to visualize the kind of areas which fall into the leases after 1979, specifically, areas which have the potential to be developed but at this time are too marginal. He asked about the leases that were granted before 1979, what leases were those? CHAIRMAN ROKEBERG stated there was a list of those leases in the research report which was given to the members. REPRESENTATIVE FINKELSTEIN asked about the types of old leases which will benefit from this legislation. More specifically, which of the old leases not being produced are close enough to the margin to be produced. Number 559 MR. COUGHLIN stated there could be one pre-1979 lease, yet he believed they are all post-1979 leases. CHAIRMAN ROKEBERG asked if that one lease was the Badami field. MR. COUGHLIN said the Chairman was correct. Mr. Coughlin then stated, in the application that BP has submitted, the area would encompass leases which are virtually all, or primarily post-1979 leases. Number 567 REPRESENTATIVE FINKELSTEIN asked about the way a lease works if it was granted in the 1970s but not put into production; is there an expiration provision in the lease? Number 570 MR. VAN DYKE stated Representative Finkelstein was correct. He continued, most of the North Slope leases have a ten year primary term. If they are not proven to be productive within that ten year period the lease will expire. Mr. Van Dyke mentioned there were certain leases which have gone farther because there were some problems with the state receiving title to the land. The leases were issued before the state had title to some of the land, and the leases have been in limbo. Mr. Van Dyke said there are some leases in this category in the Colville River Delta, in what is labeled Kuukpik (ph) on the map, and certainly Prudhoe, and Kaparuk are older leases within those unit areas. Number 584 REPRESENTATIVE FINKELSTEIN said this leads to the question of what would be the significance of justifying this legislation to leases after 1979 that are little known in this pre-1979 category, and would there be any disadvantage in leaving out the pre-1979 leases. Number 587 MR. VAN DYKE responded a majority of the Cook Inlet leases pre- 1979, however, most of those leases that are still in effect are producing leases or have produced at some time in the past. Number 594 REPRESENTATIVE FINKELSTEIN stated he was presenting a theory which he is sure has some exceptions. Number 600 MR. COUGHLIN stated they were the target of the law before this amendment, and they remained a concern of the industry and the Division of Natural Resources in trying to maximize revenues for the state, because you can have a lease which has been producing for a long time which would have been issued before 1979, and because it has now started to decline in production profile curve, it may need a royalty reduction which would be to the mutual benefit of the state and to the lessee to reduce the royalty so we can get increased production and more money. Otherwise, the company may stop producing. Number 610 CHAIRMAN ROKEBERG stated we could reach the point of a zero royalty and a zero severance and still be worthwhile to produce because it creates jobs. He asked Representative Finkelstein about the comments he made about the shut-in wells. Number 615 REPRESENTATIVE FINKELSTEIN stated he was trying to get to the broader category of what is covered here and your point reminds me there are plenty of marginal ones on the downside, as well. CHAIRMAN ROKEBERG responded to Representative Finkelstein by stating he has addressed a question he has had, which is, are there shut-in wells whose leases have expired that might be subject to reopening, and what scenario would they be under, the 25 or 50 percent? MR. VAN DYKE said if the lease has expired, then it is gone. CHAIRMAN ROKEBERG agreed and said there would presumably be a new lease to reopen the shut-in well. He then asked if there were expired leases with shut-in wells which might benefit from the royalty reduction? Number 625 MR. VAN DYKE stated, for the most part the wells would have been plugged and abandoned so they would not be very easy to reenter. Number 628 CHAIRMAN ROKEBERG mentioned when you plug a well on the North Slope, there may still be the possibility of future production. This probably would not be the case on the Kenai Peninsula due to the amount that it would cost. Number 630 MR. VAN DYKE said they have certainly reissued leases in the past, and issued leases on land that contain plugged and abandoned wells. Number 633 CHAIRMAN ROKEBERG stated he would like to bring up two other major questions. First, is the issue of appealability, what it means and its relationship to a third party and due process. This is because the legislation says the decision of the commissioner is not appealable, and we want to figure out what that means. The other big issue, which this statute is silent on, but which I am very concerned about is what I call the integrity of the bid leasing process. In other words, if we enact this particular royalty bill will this encourage them to engage in "bait-and-switch" bidding on competitive lease sale where they can highball a bid to get control of the acreage, then come back later and ask for a royalty reduction. I think we must establish trust and faith, but this is a concern I have. I would like to have some feedback on these topics. Number 654 MR. VAN DYKE said they would share some ideas with the committee. He then mentioned, a lot of this depends on whether you are bidding the royalty rate and then you bid higher than you wanted to, or whether you are bidding cash and there is a fixed royalty rate to start with. Number 657 CHAIRMAN ROKEBERG stated it may be preferable to just have fixed royalty bidding in the future and let the other variables come into play. This, however, would only marginally affect future leases. There are also some which it would have no affect on. He then stated he was concerned about future bidding, and it may be a fix to leave the rate at 12.5 percent without any other variable. There are some other things that I won't bring up right now. Number 666 CHAIRMAN ROKEBERG asked if there were any further questions. Number 667 REPRESENTATIVE FINKELSTEIN mentioned he would like see if there was any way the statements could be removed from the law could be retained with some variations. He mentioned the two statements on page 3 dealing with the possible economic return. He asked if there was a way to put this into the context of long-term economic return, or if there was a way to keep the concept but require a long-term economic analysis. Number 675 CHAIRMAN ROKEBERG asked about a reasonable rate of return for this program. CHAIRMAN ROKEBERG thanked Mr. Coughlin and Mr. Van Dyke for attending. ADJOURNMENT At 11:55 a.m. Chairman Rokeberg adjourned the meeting.