HOUSE SPECIAL COMMITTEE ON OIL AND GAS January 23, 1996 9:11 a.m. MEMBERS PRESENT Representative Norman Rokeberg, Chair Representative Scott Ogan, Vice Chair Representative Gary Davis Representative Bill Williams Representative Tom Brice Representative Bettye Davis Representative David Finkelstein MEMBERS ABSENT None COMMITTEE CALENDAR 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." - PASSED CSHB 325(O&G) OUT OF COMMITTEE PREVIOUS ACTION BILL: HB 325 SHORT TITLE: ROYALTY SUSPENSION: N. SLOPE HEAVY OIL SPONSOR(S): REPRESENTATIVE(S) GREEN JRN-DATE JRN-PG ACTION 04/28/95 1633 (H) READ THE FIRST TIME - REFERRAL(S) 04/28/95 1633 (H) OIL & GAS, RESOURCES, FINANCE 10/17/95 (H) O&G AT 01:00 PM ANCHORAGE LIO 10/17/95 (H) MINUTE(O&G) 11/14/95 (H) O&G AT 02:00 PM ANCHORAGE LIO 11/14/95 (H) MINUTE(O&G) 01/18/96 (H) O&G AT 10:00 AM CAPITOL 124 01/23/96 (H) O&G AT 09:00 AM CAPITOL 124 01/26/96 (H) RES AT 08:00 AM CAPITOL 124 WITNESS REGISTER JEFFREY LOGAN, Legislative Aide to Representative Joe Green Alaska State Legislature State Capitol, Room 24 Juneau, AK 99801 Telephone: (907) 465-4931 POSITION STATEMENT: Provided information on HB 325 ED BEHM, Heavy Oil Team Leader Milne Point Unit OXY USA, Incorporated Midland, Texas 79710 Telephone; (915) 685-5673 POSITION STATEMENT: Commented on HB 325 BRUCE POLICKY, Manager Milne Point Unit BP Exploration (Alaska) Incorporated 900 East Benson Boulevard Anchorage, Alaska 99519 Telephone: (907) 564-5232 REPRESENTATIVE JOE GREEN Alaska State Legislature State Capitol, Room 24 Juneau, AK 99801 Telephone: (907) 465-4931 POSITION STATEMENT: Sponsor of HB 325 KENNETH A. BOYD, Director Division of Oil and Gas Department of Natural Resources 3601 C Street, Suite 1380 Anchorage, Alaska 99503-5948 Telephone: (907) 762-2547 POSITION STATEMENT: Commented on HB 325 CHARLES LOGSDON, Chief Petroleum Economist Oil and Gas Audit Division Department of Revenue 550 West Seventh Avenue, Suite 570 Anchorage, Alaska 99501 Telephone: (907) 276-1363, Extension 265 POSITION STATEMENT: Commented on HB 325 JON TILLINGHAST, Attorney OXY USA, Incorporated One Sealaska Plaza, Suite 300 Juneau, Alaska 99801 Telephone: (907) 586-1400 POSITION STATEMENT: Commented on HB 325 ACTION NARRATIVE TAPE 96-1, SIDE A Number 000 The House Oil & Gas Special Committee was called to order by Chairman Norman Rokeberg at 9:11 a.m. Members present at the call to order by Chairman Norman Rokeberg were Representatives Rokeberg, Ogan, G. Davis, Williams, Brice, and B. Davis. Representative Finkelstein was absent. A quorum was present. This meeting was teleconferenced to Anchorage/ HB 325 ROYALTY SUSPENSION: N. SLOPE HEAVY OIL CHAIRMAN ROKEBERG announced that the agenda was HB 325. He announced that at the November 14, 1995 meeting a committee substitute for HB 325 was adopted, version 9-LS1122\K. Number 250 JEFFREY LOGAN, Legislative Aide to Representative Joe Green who is the sponsor of HB 325, was first to testify. He said a thorough review of CSHB 325 has not been done, but he urged committee support for HB 325. Number 302 REPRESENTATIVE SCOTT OGAN asked for a brief outline of the CSHB 325. Number 310 CHAIRMAN ROKEBERG announced that Representative Joe Green had joined the committee. Chairman Rokeberg then gave a brief overview of the changes in CSHB 325 which included changes in the language from the United States code definition of heavy oil to a definition of 20 degrees API gravity. Additionally CSHB 325 provides a ceiling of $15 per barrel of oil, in the event that there is an increase of prices. The last change was an addition of a sunset provision after ten years. Number 522 REPRESENTATIVE OGAN moved for the adoption of CSHB 325, version 9- LS1122\R. Hearing no objections it was so ordered. Number 545 ED BEHM, Heavy Oil Team Leader, Milne Point Unit, Occidental Oil, Incorporated, was next to testify. He gave a brief overview of Occidental Oil Company and stated that the Milne Point Unit is a significant asset to Occidental. He referred to a hand-out with the front page reading, "Who is Occidental Oil and Gas Corporation." He said a pilot project in the Schrader Bluff has produced about 3,500 barrels of oil per day. The wells have produced steady rates of oil but on a marginal rate. He described heavy oil as having low gravity, being thick, produces slowly over a long period of time, it is disadvantaged in market place especially with the North Slope transportation costs, and it is capital intensive. MR. BEHM said Occidental did a project five years ago in which they dug 21 wells in order to proof up technology. They spent $126 million, producing 275 barrels of oil per day per well for an expected recovery of 13 million barrels making the recovery rate at $9.30 per barrel making it uneconomical. MR. BEHM said HB 207 was seen as a positive change in Alaskan legislation. He said the key is to get the project to a competitive investment level with other opportunities worldwide. He said that a 15 percent rate of return is needed to cover overhead, cost of capital, and some risk Occidental thinks that more Schrader Bluff wells could be drilled by as early as the Spring of the 1995 forecast. He said this 15 percent rate of return has been listed in other sources worldwide. MR. BEHM said studies in the Schrader Bluff area determined the rate of return at 12.8 percent with a payback period of 6.5 years. These figures are not conducive to investment, but with the support of straightforward legislation such as HB 325 they can be economically viable. With proposed legislation in HB 325, the rate of return drops to 15.9 percent with a payback period of 5.4 years and a profit of $100,000 per well. He said this is not a windfall profit to oil companies. MR. BEHM talked about the effects on the state with the development of heavy oil. He said a company will reinvest in wells every year, for a total investment time of ten years. So, the state will end up receiving more revenues from more wells at the conclusion of the royalty holiday. Number 1179 CHAIRMAN ROKEBERG asked if Occidental would be able to take advantage of CSHB 325 in terms of the settlement agreement between Occidental and the Department of Natural Resources. Number 1200 MR. BEHM said he could see no affect of CSHB 325 on the settlement. Occidental is honoring the terms of the settlement which states that they cannot benefit from changes in state law for a four year period. He added that at the time of the settlement, heavy oil development at Schrader Bluff was not even a consideration. Number 1246 CHAIRMAN ROKEBERG reviewed the terms of the Occidental litigation. He then asked what Occidental future would be in capital development if royalty relief was not granted. Number 1284 MR. BEHM said Schrader Bluff is roughly half of the potential of the unit and if it were deemed noncommercial, it would limit Occidental's investment in the state of Alaska. Number 1320 CHAIRMAN ROKEBERG asked if it would cause Occidental to follow the 25 oil companies that have left the state. Number 1339 MR. BEHM said, as a corporate philosophy, assets are not kept that cannot produce. He added that there would be a high risk of Occidental leaving within the next two years and it would be his recommendation that they do so. Heavy oil investment would not happen without supporting legislation. Number 1390 BRUCE POLICKY, Manager, Milne Point Unit, BP Exploration (Alaska) Incorporated, was next to testify. He said that his responsibilities include subsurface development at Milne Point. Mr. Policky referred to a handout titled "Heavy Oil Potential at Milne Point" in his testimony. He said the most promising thing that BP has discovered at Milne Point is that although production rates are low, they hold up over time. He said that between Schrader Bluff and the West Sak River there are an estimated 26 billion barrels of oil. Currently there is only .3 percent under development in this area. Number 1572 MR. POLICKY said from the first pilot project oil companies have learned how to drill and complete wells in heavy oil areas, especially how to manage production and costs. This completion technology can be utilized in future developments. He said BP is currently setting a platform for future developments slated for 1998. The objective is to demonstrate lower capital costs and higher production rates from the well, or at least what would be feasible. In 1995, six wells were drilled at a cost of $15 million. There have been some construction delays in those wells involving the commission of heaters to bring well on line. This phase should be completed within the next two weeks and no later than the end of February. The delays did not have to do with the wells, but with the surface facility work. He said there are promising developments with electric submersible pump life which has reduced operating costs. Number 1807 MR. POLICKY said that in the past the cost of drilling a well in the Schrader Bluff area was $2.4 million. Currently the cost of drilling a well with the completion costs to $1.6 million to $1.7 million. Work has been done to develop this area with fewer pads and less infrastructure as nearly half the costs of the development are spent in this area. He discussed new technology including frac packing, electric submersible pumping and heat trace technology. Number 1980 MR. POLICKY said BP would need cost reductions, increased production and development incentives in order to increase investment in this area. He noted the recently passed fiscal note which was passed with the belief that increased production and decreased costs would be all that would be needed to begin heavy oil development. Mr. Policky stated that BP has yet to come up with a development strategy with just those two factors that would draw international investment. Number 2050 MR. POLICKY said that within Schrader Bluff there are 2 billion barrels with an ultimate recovery between 200 million to 800 million barrels. He stated that perhaps this biggest plus for development of Schrader Bluff would be the expansion into adjacent fields. He said the experience and the increased technologies will be advantageous when you move to other more low lying fields with oils containing lowered API gravities. Number 2174 MR. POLICKY said HB 325 would reduce uncertainty, encourage development through less dependance on higher initial production rates, and it would accelerate the pace and increase development scope. In Schrader Bluff the time lag from incentive to start of investment is short because of the existing infrastructure. He said that because of the immaturity of the project, the ultimate project scope remains uncertain at this stage. Number 2200 CHAIRMAN ROKEBERG asked about the decline rates of production in the oil wells. Number 2234 MR. POLICKY said decline rates at a Schrader Bluff well experience a steep decline in a period of six months to a year. A typical well begins with a 300 barrels of oil per day, dropping down to 200 barrels of oil per day. He said long term decline rates of about 6 percent a year at Schrader Bluff compared with 15 to 20 percent at Kuparuk and 18 percent at Endicott. Number 2267 CHAIRMAN ROKEBERG asked if there is a flat production line as a result of continued reinvestment and development of the field. Number 2277 MR. POLICKY said there is a nine year period of development of a well. The first two years consist of the development of a facility followed by continued drilling. He said there is a 30 to 70 percent production split and inherent within this is a 16 percent recovery factor. He said that enhanced recovery projects would boost that production rate. Number 2335 CHAIRMAN ROKEBERG received confirmation those factors cause the difference between the figures of 300 million and 800 million. Number 2350 MR. POLICKY said there are risks of delay and development especially in the area of development momentum. He added that anytime projects are delayed economic benefits are deferred and values lost as well as losing the infrastructure. REPRESENTATIVE GREEN referred to the Occidental testimony and asked about the possibility of projects going forward without the royalty holiday. MR. POLICKY said that the project might or might not go forward. He added that the project would accelerate with the royalty holiday as it pushes investment past the hurdle rate. SIDE B Number 000 REPRESENTATIVE GREEN asked if the fiscal note was realistic in its supposition that projects would be developed without royalty holidays. MR. POLICKY said it is not certain development would occur without incentives. Number 22 REPRESENTATIVE BRICE asked about employment expectations. Number 65 MR. POLICKY said that there are two periods of development. The initial stage of the first two years would see the employment of 350 people, about two-thirds Alaska hire. The second stage would result in 60 direct jobs a majority of them being locally employed. Number 106 CHAIRMAN ROKEBERG pointed out pages 18 and 19 of the report titled, "An Opportunity to Develop Alaska's Heavy Oil Resources." which listed the impacts of heavy oil development. He received confirmation that this would be a near term impact because of the infrastructure that is already in place. Number 198 CHAIRMAN ROKEBERG asked if you had a step-out or a directional well that went down the bore hole, into a different lens of production, beyond whatever you were producing, for purposes of the HB 325, would this be listed as a new well. Number 215 MR. POLICKY repeated the question by saying that if you had a well and complete it within a particular zone and then sometime later we move up into a second zone, when the question was confirmed, he answered that he would not consider that a second well. Number 254 CHAIRMAN ROKEBERG asked for the differences in revenue to the state listed in the Occidental testimony. MR. POLICKY said figures were developed by creating a ratio to the amount of barrels produced rather than to no increased investment and production. Number 265 REPRESENTATIVE OGAN asked Mr. Policky to speculate on the overall potential for heavy oil is and how it would affect the life of the pipeline. Number 284 MR. POLICKY said the University of Alaska-Anchorage study said that increased flow of oil means decreased tariffs which results in decreased field costs. If the life of the pipeline is extended this results in the increased well head value, in existing fields, of approximately $60 million to $80 million. Within the Milne Point Unit, total production field rates could reach 60,000 barrels per day and rates could be higher within the Kuparuk River Unit as well. CHAIRMAN ROKEBERG recognized the attendance of Representative Finkelstein at 10:05 a.m. Number 370 KENNETH A. BOYD, Director, Division of Oil and Gas, Department of Natural Resources, was next to testify. He announced that he was accompanied by Bill Van Dyke. He said that HB 325 does not include any economic analysis. He said the presentations by Occidental and BP do provide some numbers but not the information backing those numbers. He said that these numbers might be applicable to any operator on the North Slope. He said the numbers of five years, 500 barrels, assume that all operators on the North Slope will have the same analysis. He added that there is no assurance that oil companies will continue to produce oil past the five year royalty holiday. The Administrations position is that HB 207 is a better vehicle to craft royalty reduction. Number 498 MR. BOYD said that the testimony of Mr. Policky is not enough guarantee that multilateral wells would be interpreted as just one well by other oil companies. Number 530 REPRESENTATIVE FINKELSTEIN asked if there were any provisions in the royalty law that would address misuse of the royalty reduction. Number 561 MR. BOYD said the Administration believes the 3 percent floor would hold. He added another factor that would prevent misuse is Occidental's settlement with DNR. After HB 325 oil companies would not be able to use HB 207 on the leases that were changed from 20 percent to 12.5 percent. Number 604 CHAIRMAN ROKEBERG asked for a methodology for the fiscal note where the Division of Oil and Gas is estimating a per well change in revenues of $28,000 per well per year. Number 615 MR. BOYD said they took the 500 barrel per day maximum, and multiplied it 12.5 percent royalty rate and then multiplied it by a net factor of $10 a barrel, multiplied by 365 days. CHAIRMAN ROKEBERG pointed out that if no wells are drilled then the loss to the state is zero which was confirmed by Mr. Boyd who then reiterated the Administration's position. Number 667 REPRESENTATIVE WILLIAMS asked for a written explanation from the Division of Oil and Gas as to how HB 207 would effect heavy oil. He questioned the logic of the Administrations criticism of a guarantee that heavy oil wells would still produce after the five year royalty suspension. He then asked what type of guarantee the Administration would want. Number 735 MR. BOYD said there is no guarantee in any provision, but that HB 207, as compared to HB 325, allows the commissioner to make the decision, on whether or not an oil development needs assistance, based on real economic analysis. Number 788 REPRESENTATIVE WILLIAMS asked if HB 207 would cause problems in project development delay. Number 830 MR. BOYD said that HB 207 would require an application process and the analysis process which would take an estimated three to six months. Number 860 REPRESENTATIVE FINKELSTEIN asked the history of applications from the North Slope oil industry under past or present provisions. Number 870 MR. BOYD said no oil company has applied under the new provisions. Number 908 CHAIRMAN ROKEBERG asked if Alaska had granted any type of royalty reduction under prior statute. Number 928 MR. BOYD described the settlement with Occidental. Number 969 CHAIRMAN ROKEBERG asked and received confirmation that HB 325 does not need the commissioners or the Governor's approval. MR. BOYD said HB 325 would have only minor administrative costs. He then expressed concern as to potential cost to the state if the analysis required under HB 207 were not done. Number 1027 CHAIRMAN ROKEBERG asked if the long range predictions of increased revenues to the state under HB 325 out weigh the short term losses in revenue. Number 1060 MR. BOYD said there is no way he could answer that question. REPRESENTATIVE FINKELSTEIN asked if historically the position of the administration is to weigh each situation on a case by case basis and to utilize the resources at the DNR and the Division of Oil and Gas. This question was affirmed by Mr. Boyd at which time Representative Finkelstein stated that HB 325 eliminates any administrative discretion. Number 1139 CHARLES LOGSDON, Chief Petroleum Economist, Oil and Gas Audit Division, Department of Revenue, was next to testify. He said the fiscal note is based on the DOR's Fall 1995 forecast from predicted royalties, as communicated by the industry, from the Schrader Bluff area. Number 1199 CHAIRMAN ROKEBERG received confirmation that the fiscal note of a negative $50 million is based on the development plans of BP but that it does not include the potential development of 230 wells over nine years in Schrader Bluff alone. He then restated the testimony as to possible increased revenues for heavy oil development and asked if it would be a fair analysis of the situation. Number 1295 MR. LOGSDEN stated that this is an unanswerable question as it all revolves around the ability to project oil prices and said he is unprepared to answer it. Number 1323 REPRESENTATIVE FINKELSTEIN reiterated the argument that because of the employment factor there are short term as well as long term benefits to the state. He said that because we do not generate a personal income tax or a sales tax isn't this factor a negative loss to the state because of the public services provided. Number 1390 MR. LOGSDEN said the focus on has been on the state revenues side and not on other factors. Number 1416 CHAIRMAN ROKEBERG asked if the CSHB 325 fixed well head price of $15 would be a fair amount. Number 1446 MR. LOGSDEN said he believes that royalty suspension could be done under the DNR's supervision, but said the $15 amount would be a step in the right direction to truncate the risk to the state. Number 1487 CHAIRMAN ROKEBERG asked if the $15 relates to the $24 federal government West Texas Intermediate price. MR. LOGSDEN said that it would be in the ball park considering the added costs associated with heavy oil and the transportation costs. Number 1530 CHAIRMAN ROKEBERG said there is a difference between the DOR's Fall and the Spring Forecast of 1995 especially in regards to the peripheral smaller wells, such as those located in Schrader Bluff. MR. LOGSDEN said he assumed that the difference involves the proposed development schedule in Schrader Bluff. Number 1624 JON TILLINGHAST, Attorney, OXY USA, Incorporated, was next to testify. He explained that HB 207 was a general royalty reduction bill for all types of fields in all parts of the state. At the development of HB 207 it was felt that the special considerations regarding heavy oil development should be addressed in a separate bill. He said that HB 207 uses a prolonged royalty reduction and precludes royalty suspension. He said the administrative process, required of major producers as well as small producers, is the same. Number 1864 REPRESENTATIVE FINKELSTEIN asked why the provision of HB 207, involving a minor 3 percent expense to the industry, arrived at by consensus, is now being questioned. Number 1969 MR. TILLINGHAST referred to the handout titled "An Opportunity to Develop Alaska's Heavy Oil Resources" and specified page 39 which was a comparative analysis of the different fiscal impacts. He said the differences between the royalty suspension compared to the 5 percent royalty found in HB 207 was not significant over time, but noted the significant negative impact upon the state in the long run with a 5 percent royalty. He then added that if you add the administrative costs with the costs of the administrative process it is significant. He said it cost Occidental $200,000 the last time they went through the process. Number 2126 MR. TILLINGHAST said DNR's position in regards to prolonging the economic life of a well has historically been interpreted as prolonging operating revenue and not assisting with inducement of capital investment. Number 2208 REPRESENTATIVE GREEN pointed out that HB 207 is discretionary, and because HB 325 is not it is more likely to induce industries to develop heavy oil. Number 2254 CHAIRMAN ROKEBERG mentioned that HB 207 received a 3 percent floor in the Senate Finance Committee. Number 2312 REPRESENTATIVE FINKELSTEIN asked about amending HB 207 to eliminate the floor. Number 2345 MR. TILLINGHAST mentioned the difficulties about just changing one section of HB 207. He then reiterated the administrative costs involved and its hinderance on smaller companies. He said Occidental would not apply, even if they could under HB 207, because of the costs and the time lag. In Occidentals case the settlement took one to two years. CHAIRMAN ROKEBERG said he was going to hold off on a amendment for a floor. TAPE 96-2, SIDE A Number 000 REPRESENTATIVE WILLIAMS made a motion that CSHB 325 be moved out of committee. REPRESENTATIVE FINKELSTEIN objected to the motion. He requested a hearing on a proposed amendment in which heavy oil fields can receive a royalty reduction consideration. CHAIRMAN ROKEBERG said that Representative Finkelstein was somewhat out of order in that he had not prepared a written version of the proposed amendment. He said that in the interests of the committee they would vote on Representative Williams motion. Number 80 REPRESENTATIVE FINKELSTEIN again requested that he be allowed to submit his proposed amendment. A discussion ensued regarding whether or not it was an amendment to HB 325 or whether it was a separate bill. CHAIRMAN ROKEBERG called for a vote on the motion to pass CSHB 325 out of the House Special Committee on Oil and Gas. Representatives Rokeberg, Ogan, G. Davis, Williams, and B. Davis voted yea. Representative Finkelstein voted nay. Representative Brice was absent for the vote. The motion to pass CSHB 325 succeeded. ADJOURNMENT There being no further business to come before the House Oil & Gas Special Committee, Chairman Rokeberg adjourned the meeting at 10:47 p.m.