HOUSE SPECIAL COMMITTEE ON OIL AND GAS April 13, 2000 6:20 p.m. COMMITTEE CALENDAR HEARING ON IRS TREATMENT OF TAPS DR&R, AND TARIFFING BY RICHARD FINEBERG TAPE 00-22, SIDE A CALL TO ORDER Representative Jim Whitaker convened the meeting at 6:20 p.m. PRESENT Members present at the call to order were Representatives Smalley, Dyson, Kemplen, Whitaker. SUMMARY OF INFORMATION CHAIRMAN WHITAKER introduced Richard A. Fineberg to testify regarding the basis of his recent Anchorage Daily News "Compass" piece on the Internal Revenue Service treatment of Trans-Alaska Pipeline Service (TAPS), "Dismantlement, Removal and Restoration" (DR&R) collections, and the effect that may have on tariffs. RICHARD A. FINEBERG explained that DR&R is the collection of payments for the dismantling of the TAPS, stating that the owners of the pipeline have, by their own calculations, collected more than $760 million for income taxes, most of which they never actually paid. He stated that this has probably cost the State of Alaska more than $160 million in revenue. He went on to say that the administration only recently discovered the problem, and that they should have discovered it long ago. According to Mr. Fineberg, Alaska North Slope (ANS) crude oil is handicapped by its relatively high transportation costs, the largest of which is the pipeline. From a policy standpoint the state should be concerned about the tariff for three reasons: First, the more it costs to deliver (ANS crude) to the refinery, the less competitive that oil will be on the world market. Second, the three companies that presently own the rights to more than 90 percent of the production, also own more than 90 percent of the pipeline, therefore standing to benefit from excessive tariffs to the detriment of non-owner shippers. (He then referred to exhibit "B" of his testimony packet) Finally, if the tariffs are excessive, that deprives the state of much needed revenue. MR. FINEBERG questioned whether the Regulatory Commission of Alaska (RCA) safeguards state revenue interests and (North) Slope competition, and suggested that the tariff has served industry purposes rather well, but (the RCA) functions as a "rubber stamp". Up until August 23, 1999, the state had been very clear that the tariffs were "just and reasonable," but on that date, reversed its position with the governor's announcement (during a speech on the BP/Arco merger) that the tariffs were excessive and a barrier to competition. MR. FINEBERG testified that while the tariff is formula driven, DR&R is "cast in concrete," a set number that is "front-end loaded" or accelerated. Further, the money is not put into escrow or a reserve account, thus creating a windfall to the pipeline owners. MR. FINEBERG stated that the disclosure of what he refers to as the "scam" came about in January, 2000, during an investigation brought about a challenge to the tariffs brought by Tesoro. The RCA had requested that all other parties to the case file briefs on various aspects of the DR&R. In preparing its response, the Department of Law discovered that although the 1985 settlement increased DR&R collections tariffs to pay the federal income tax, the TAPS owners then "took federal tax deductions for TAPS DR&R in advance of incurring the actual expense." The Department of Law brief says the TAPS agreement assumes that DR&R funds are treated as taxable income, so the TAPS owners cannot take a deduction for DR&R expenses until the actual expense is incurred". MR. FINEBERG, in answer to a question by Chairman Whitaker, described how he arrived at his initial statement regarding the amount of money this means to the state and to the producers. MR. FINEBERG quoted from the Department of Law's filing to the RCA, wherein it states that Exxon had filed a petition in United States tax court in 1990 to increase its deduction. In the IRS ruling, the need for an income tax surcharge for DR&R was eliminated. MR. FINEBERG stated that an attorney for the Department of Law told him that the department is still trying to obtain documents to determine what actually happened to both the state and federal income tax payments, and that it would be premature to quantify the consequences at this time. MR. FINEBERG found, from public records, that the TAPS owners and the state have said that the owners have collected $765 million ($663 million for federal taxes and $152 million for the state) through the years of the tariff. He then looked at how the state income taxes are collected, and commented that even though the state and the IRS cannot comment as to whether or not the taxes have been paid, nothing would prevent BP from answering the question of its own volition. He went on to suggest if the recent $460 million payment of tax settlement to the State of Alaska included compensation for the failure to pay tax on the income they received for TAPS DR&R, the following question should be asked: To avoid recurrence of similar problems, was a penalty sought or collected? MR. FINEBERG then commented that it is unusual for the Department of Law to be both making and executing policy. Typically, the department represents a state agency such as the Department of Natural Resources or Department of Revenue. He said he has discovered in various conversations over the last year that many of the people who have formulated state oil and gas revenue administration and collection policies, are responsible for implementing those policies today. He noted that the external counsel who assisted the Department of Law in negotiating the 1985 TAPS tariff settlement has continued to represent the state in pipeline tariff matters at FERC (Federal Energy Resource Commission). He mentioned several indicators that might have prompted a look at this problem prior to this year: several of his reports, testimony at the settlement hearings pointing out the potential for problems, and articles in publications. CHAIRMAN WHITAKER asked Mike Barnhill to respond to Mr. Fineberg's comments and reassure the committee that the department is looking into the matter. MIKE BARNHILL, Assistant Attorney General, Oil, Gas and Mining Section, Department of Law, responded that he does not agree with what Mr. Fineberg said in his article, and thinks those allegations were premature. He testified that he has asked the RCA to investigate this and develop a factual record. He explained how the whole DR&R issue arose from the TAPS tariff litigation by the state, including the inclusion of the tax payments. After deciding how much money would be needed for DR&R came the discussion of how to collect enough money for pipeline dismantlement and how to approach the tax treatment of that amount. MR. BARNHILL, in responding to RCA's question about the appropriate treatment of the DR&R payments, came across information that raised questions about the collection and or payment of federal income tax monies collected through the tariff. He went on to say that it is very early in the investigation of this issue. He expects the RCA in the not so distant future to issue a ruling on his request, set a procedural schedule, and afford the department the opportunity of discovery. That discovery will allow the department will develop a factual record. But until the department obtains all the facts, they just don't know (whether there is any malfeasance). MR. BARNHILL, in response to a question by Representative Dyson, stated that the IRS agreement with the TAPS carriers was made in 1988. REPRESENTATIVE GREEN asked Mr. Barnhill to comment on the effect that an extension of the life of the TAPS line would have on the collection of DR&R funds. MR. BARNHILL stated that the collection schedule was front-end loaded, and that almost all of the money the carriers had been committed to collect for DR&R had already been collected. The issue, in his opinion, is how the money collected will accrue. The operators, at the time of the TAPS settlement agreement, had not anticipated that the pipeline could last until 2030; but now, almost everyone agrees that it could, and production predictions extend until 2020. REPRESENTATIVE GREEN stated concern over how the DR&R monies would be handled in relation to oil industry with mergers and sales; and, that despite the amount of money already collected, the cost of DR&R, after inflation, might exceed that amount. MR. BARNHILL answered that with the accrual of interest, the amount of money will grow, and should cover it, unless the rate of inflation exceeds it. REPRESENTATIVE PORTER asked if there was a separate account for the DR&R money. MR. BARNHILL replied, "No, all the DR&R collections are taken into income by the TAPS carriers, and there's no requirement that the money be kept in a separate account either internally or externally, and that is why they are legitimately subject to state and federal corporate income tax." MR. BARNHILL, in response to a question from Representative Kemplen, said that at the time of the 1985 TSM agreement, the parties didn't know that the IRS would rule in favor a deduction. He could not speculate how that knowledge might have affected the settlement. He did say that the DR&R charges would be less, but how much less, he didn't know. REPRESENTATIVE KEMPLEN expressed concern that considering the fact that this situation was discovered as the result of "ancillary" research, he was wondering what else might be out there and asked if there were some type of auditing being done on TAPS tariffs. MR. BARNHILL answered that the state has the right to audit all of the TAPS carriers tariffs on an annual basis, and that has been done regularly since at least 1990. But the audits look at whether the costs the carriers include in their tariffs are "prudent" costs, not whether certain provisions of the settlement agreement are appropriate, he explained. REPRESENTATIVE KEMPLEN asked what had been done during the years 1985 to 1990. MR. BARNHILL said it is possible that audits had occurred during that time, but that he just didn't know. He explained that the Department of Law it is not charged with examining the formula relating to the tariff, but with auditing the input into that formula. He went on to say that the Department of Law has sufficient concern about the tax deduction issue that they would like to get some more information about it. REPRESENTATIVE PORTER asked whether any of the recent settlements preclude the [state's] ability to go back and look into this. MR. BARNHILL answered that it is a possibility that they do, but that is not something that he has looked at yet. In response to a further question by Representative Dyson as to what lessons we've learned and how we could do better with regard to watching for this type of situation, Mr. Barnhill stated that during the 1985 settlement the state tried to look at all of the possibilities. However, this issue involved federal taxes and thus it would be particularly difficult to obtain the information. He was not sure that the state would have asked specifically if the carriers were going to seek a deduction of the taxes on the DR&R funds, but he supposed he could find that out. CHAIRMAN WHITAKER, in conclusion, asked Mr. Barnhill to reaffirm that the Department of Law is looking into this matter. MR. BARNHILL responded in the affirmative. ADJOURNMENT The meeting was adjourned at an unspecified time. NOTE: The meeting was recorded and handwritten log notes were taken. A copy of the tape and log notes may be obtained by contacting the House Records Office at Room 229, Terry Miller Legislative Office Building, 129 Sixth Street, Juneau, Alaska 99801-1182, (907) 465-2214, and after adjournment of the second session of the Twenty-first Alaska State Legislature, in the Legislative Reference Library.