HOUSE RESOURCES STANDING COMMITTEE February 15, 1995 8:04 a.m. MEMBERS PRESENT Representative Joe Green, Co-Chairman Representative Bill Williams, Co-Chairman Representative Scott Ogan, Vice Chairman Representative Alan Austerman Representative Ramona Barnes Representative John Davies Representative Irene Nicholia Representative Eileen MacLean MEMBERS ABSENT Representative Pete Kott COMMITTEE CALENDAR Presentation by Ken Thompson, President, ARCO Alaska Presentation by Jim Palmer, Director, External Affairs, BP Exploration (Alaska) WITNESS REGISTER KEN THOMPSON, President ARCO Alaska, Inc. P.O. Box 100360 Anchorage, AK 99510 Phone: 265-6132 POSITION STATEMENT: Made presentation to committee JAMES PALMER, Director External Affairs BP Exploration (Alaska) Inc. P.O. Box 196612 Anchorage, AK 99519 Phone: 564-5485 POSITION STATEMENT: Made presentation to committee ACTION NARRATIVE TAPE 95-16, SIDE A Number 000 The House Resources Committee was called to order by Co-Chairman Green at 8:04 a.m. Members present at the call to order were Representatives Austerman and Green. Members absent were Representatives Williams, Ogan, Barnes, Davies, Kott, MacLean, and Nicholia. CO-CHAIRMAN JOE GREEN said the presentation by Ken Thompson from ARCO Alaska and Jim Palmer from BP Exploration will address a new concept in state and company relationships. He noted the state is at a time when some innovative ideas are necessary. KEN THOMPSON, PRESIDENT, ARCO ALASKA, INC., thanked the committee for the opportunity to testify on an important matter for industry and for the people of Alaska. He began by reviewing his agenda. He said he will be talking about common goals shared by industry and Alaska and how they can work together to achieve those goals. He stated key to those goals is the question--can new things for new projects be done in industry in Alaska to increase the international competition and make it more competitive in Alaska versus other countries. He said he will describe tax and royalty regimes in 70 other countries, showing how they compare to Alaska. MR. THOMPSON noted he will comment on what it takes to be more competitive and create more jobs, as well as more revenues, for the state and industry. Finally, he said he will talk about what immediate actions can be taken near term, and the next steps to be taken on a long term basis, to make Alaska more competitive which could result in better sustained economic development, meaning jobs and incremental revenues for the state. (Representatives Williams, Ogan, Davies and Nicholia joined the committee meeting.) MR. THOMPSON, referring to overheads, (may be found in the House Resources Committee Room, Capitol Room 124, and after adjournment of the second session of the 19th Alaska State Legislature, in the Legislative Reference Library) stressed the state and ARCO share important common goals including jobs for Alaskans. He said ARCO believes they can create new economic activity for those who work in the industry. He noted each job with ARCO creates three and one-half jobs in the service sector, as well as jobs in retail. He explained another common goal is incremental revenues. ARCO believes there can be incremental revenues created for the state and for ARCO and the industry derived from new production. ARCO is not proposing and will not be proposing any changes in producing reservoirs in existing fields. He stressed ARCO's emphasis will principally be on marginal development in new fields or on how to spur an increase in exploration activity. MR. THOMPSON noted there is some sensitivity about what might be proposed in regard to the permanent fund in particular. ARCO sees an opportunity to increase permanent fund contributions through new activities and new revenues. He stressed ARCO believes that any proposal industry and state comes up with together should maintain current contribution levels. Therefore, there is a need to be innovative. He said any new opportunity can create from zeros to positives. He noted a recent news report that said, "it is better to have half a loaf than no loaf." MR. THOMPSON stated the common goals of jobs and revenues can be created and achieved through sustained economic development which can be done through new exploration, marginal developments, and the extension of field lives. He stressed to achieve sustained economic development, leading to jobs and revenues, it is very important to understand how the business environment in Alaska must become more competitive. He said the industry realizes it has to do its share such as greatly reducing costs and changing the cost of living within the company. He pointed out industry is doing that through new innovations, working together better with its service companies and partnerships, and also in developing new, more cost effective technologies in Alaska. Number 153 MR. THOMPSON discussed what is happening in the rest of the world in some key areas that have seen new incremental projects brought on, and areas that have created new jobs and revenues. Australia introduced a resource rent tax in 1985 for offshore projects, meaning they have a flat 33 percent corporate income tax, which is all the burden producers will pay. He noted once producers achieve a certain rate of return on their investment, then they have additional revenues they get via a resource rent tax. He said if a small field is involved or oil prices are low, the resource rent tax would not be recovered because the rate of return will not have been met. MR. THOMPSON told committee members that in Venezuela, the income tax rate for extra heavy crude development was lowered from 67 percent to 34 percent and there was the removal of onerous tax provisions for multinational firms. He noted that country has also improved the bidding structure for marginal fields. He explained that ARCO currently is in discussions with Venezuela on a large multi-billion dollar deal and stressed two years ago they would not have been there. MR. THOMPSON stated fiscal reformations in Alberta/Canada revived the oil and gas industry there. He said Norway completely abolished royalties on new fields in 1986 and removed the sliding scale state participation for new leases in 1992. He pointed out the United Kingdom (UK) abolished royalties entirely, going from 12.5 percent royalties to zero royalties on all new fields. In the UK, they also had a production revenue tax, similar to Alaska's severance tax, which has gone from several percent to zero to encourage development in new fields. He noted the changes have led to a revival of the UK oil industry which was a country that had a production curve heading down. He said last month the UK achieved record production in the history of the UK as a result of establishing incentives. Number 208 MR. THOMPSON showed an overhead outlining the fiscal regime comparison as of 1994 on new fields. He noted these countries have not made changes in their tax and royalty structure on existing production. He said in the UK, royalties have been eliminated and they no longer have ad valorem taxes or severance taxes. He stated Australia has no revenue taxes or ad valorem tax. He noted that in Australia once a company has invested, and they discover a large field and recover their investment, there is additional taxation called a resource rent tax which kicks in and can get up to 5 or 10 percent. He stressed the tax varies tied to the oil price. He explained currently the total burden in Australia and the UK is about 33 percent which is received on a profit based taxation, not revenue based. In Alaska, industry faces 39 percent corporate income taxes, royalties which average 12.5 percent to 13 percent, a production tax which varies from 0 percent to 15 percent, and the ad valorem tax of 2 percent. Number 245 MR. THOMPSON said ARCO has worked with outside consultants in looking at the tax and royalty regimes in 70 different oil producing countries. He pointed out that most of the tax and royalty regimes in foreign countries fall into two types of overall systems. He explained the first system is the production sharing contract. In a production sharing contract, after a company makes an investment, they get a very high share of the production until their capital is recovered. After that point, profits are shared and in many cases that sharing is 50/50. He stated some of those do have royalty but only after capital is recovered. MR. THOMPSON told committee members that some countries have a tax and royalty system similar to the United States and Alaska. Less than one-third have a tax royalty type fixed system. More than two-thirds have a variable type of royalty or net profits type of share. When looking at the larger oil producing countries--those producing over 200,000 barrels of oil a day--only 3 out of 22 have a fixed royalty system and Alaska is one. He pointed out that 19 of 22 nations either have a variable type royalty, a net profits type of system, or a production sharing contract. He said many of these changes have taken place since the fall of communism. These countries have become more free market and want to create a better economy for their own people. For example, while ARCO's capital budget was trimmed for Alaska, ARCO International is seeing increased capital budgets for Indonesia, the Middle East, Ecuador, China, and Algeria. Number 311 MR. THOMPSON commented on what it takes. First, it takes industry working with the state to develop that competitive environment to understand how these other countries are getting more capital to create jobs and revenues. He said a key is ARCO's support of the state's effort to achieve a soft landing called Alaska's budget. He complimented the legislature and the Administration's efforts to focus on balancing the budget, so that if any incentives are given today or changes are made, they can be honored in the future because the state is in a very healthy economic situation. ARCO believes, emphasizing new projects, that a competitive tax and royalty structure should be developed in an innovative way. MR. THOMPSON stated it would also be helpful to transition to a more flexible regulatory environment, where the state is more willing to consider alternative business arrangements, when necessary, to move forward on small or marginal projects. He said the industry also realizes it must focus on keeping cost structure low. Industry feels there are things it can do such as innovations to lower lease operating costs through new technologies. He added industry feels it is important to bring in new companies/competitors to Alaska who can help share the risks of exploration but also believes in doing that, the very high standards on environmental protection and safety must not be lowered. Number 346 MR. THOMPSON commented on immediate actions for the short term which ARCO recommends. He said ARCO recommends that the legislative intent for the application of existing incentives be reviewed and clarified. He stated in doing that, the following questions will be asked. Are the incentives being used effectively? Are the incentive used in the way the legislature intended? Are the incentives obtaining the results expected? He noted that currently, technical teams at ARCO and other companies are working closely with the technical teams at the various commissions to examine many of these incentives and hopes to soon propose legislation which will address these questions and even make some of the incentives more clear. MR. THOMPSON said in regard to the exploration incentive credits, he has worked every oil basin in the United States (U.S.), and has worked most of the foreign countries mentioned earlier. He felt the state's exploration incentive credit is good and could spur exploration. However, since the incentive credit was approved, ARCO has applied three times for wildcat wells and has been rejected three times. ARCO believes the current rules and guidelines are unclear and what qualifies and what does not qualify is not clear. He stated a simple change would be defining exploration by the Internal Revenue Service (IRS) or the Securities Exchange Commission (SEC) guidelines which might make it very effective for the exploration incentive credits. MR. THOMPSON noted that ARCO Alaska has a fixed exploration budget. The budget in the past was almost $200 million and this year it is $20 million. He explained the reason for the change is the fiscal regimes in other countries which allow acceptable rates of return. He noted even with a fixed budget, ARCO Alaska is the largest explorer in Alaska, and this year will be drilling four exploration wells. He said if ARCO Alaska was to use something as simple as using the IRS or SEC guidelines for exploration and getting the incentives, ARCO's budget would allow drilling up to six exploration wells. He pointed out that change could have the same effect on other companies, perhaps even bring some new companies into the state, which also allows a statistical higher chance of a field discovery. MR. THOMPSON stated the existing lease sale schedule program is not working well as far as a regular schedule for leasing. A lot of effort is put forth in getting prepared and sometimes the sales are delayed or there are major lawsuits involved. He said ARCO Alaska does applaud the legislature's effort to try to improve the lease sale schedule through HB 308. He hoped that ARCO Alaska and the legislature can work together to make HB 308 work. MR. THOMPSON explained the discovery royalty credit is a credit given to a new exploration well and the lease of discovery, and allows royalties to go from 12.5 percent 5 five percent for 10 years. He stated the remaining leases in the field receive no royalty credits. He noted this credit would provide more of an incentive if, for example, the credit was applied for five years from the date of initial production and/or was applied to leases covering the entire discovery. He said this would make investment in the new fields more attractive because the credit would lower up front development costs. MR. THOMPSON stressed a key recommendation is the review and support of flexibility in the Department of Natural Resources (DNR) to provide royalty relief. He said in current law there is a lot of flexibility in lease sale terms. For example, in lease sale 79 coming up this summer, there is a wide range of lease sale terms which could be recommended such as a net profits type of term. This type of term would make that lease sale competitive worldwide. He stressed the fixed royalty for that lease sale does not make it competitive. He pointed out there are existing laws which allow the flexibility but they need to be reviewed and supported. MR. THOMPSON stated in smaller discoveries, it is very difficult to move forward with economic investments. Many of the laws and regulations consider the large Prudhoe Bay type of fields. ARCO Alaska has several smaller fields and believes there are several left to discover in Alaska but more flexibility is needed there also. He said prolonging economic life especially relates to the Cook Inlet and Kenai Peninsula producers. He noted existing regulations to prolong economic life do provide royalty relief if people can show economic need. MR. THOMPSON said prolonging economic life is a good piece of legislation but is very difficult to obtain and the administrative burden is a nightmare. One producer recently applied, for a field where they were losing money, for royalty relief to extend the field life which also means peoples' jobs. In that case, the law stipulates providing data for revenues and costs all the way back to the date of discovery. He noted the field being discussed was over 20 years old and had changed hands several times. The producer could not find the original records all the way back to discovery, although they had excellent records for the past several years. The request was denied because the law stipulates all data back to the date of discovery must be provided. He stressed that was a field which could have had prolonged economic life for jobs and revenues. He pointed out the regulation could be modified to require only the last five years of economic data to show there is a need. (Representatives MacLean and Barnes joined the committee.) MR. THOMPSON said ARCO Alaska also requests the legislature to support any federal tax incentives for oil and gas development. He noted there are currently ongoing discussions, at the federal level, about different types of incentives. He stated when those incentives come up, ARCO Alaska urges Alaska's support. He noted that ARCO Alaska also appreciates the state's support in efforts to open the Arctic National Wildlife Refuge (ANWR) and lift the export ban. MR. THOMPSON said these immediate actions for the short term means the next few weeks and months. He said ARCO Alaska recommends its technical staffs work with the various commissions and their technical staffs to address most, if not all of these recommendations and then bring forward proposals for either legislation or minor modifications in existing legislation. Number 479 MR. THOMPSON stated those short term recommendations may not be sufficient for the long term in regard to sustained economic development. He commented on recommendations for the long term. ARCO Alaska urges the legislature to support and participate in a broad based process to develop recommendations aimed at enhancing Alaska's long term international competitive position. ARCO Alaska believes strongly that any of these initiatives should be broad based, there should be a public consensus that the right thing is being done, and there should be a bipartisan process involving a lot of cooperation between the legislature, the Administration, and the industry. Mr. Thompson noted that many are eager to move forward to make changes that would make Alaska more competitive and he appreciates and encourages that enthusiasm. However, he cautioned it is a complex issue requiring a lot of thought and public buy-in. MR. THOMPSON pointed out the first effort should be gathering information (such as shown earlier) on competitive fiscal regimes. If there is fixed capital available in the worldwide industry, how does Alaska capture more of that? He said ARCO has been a customer in Alaska for over 40 years and is committed to Alaska long term. He stated ARCO Alaska likes shopping in Alaska but stressed there are large discount warehouses that have moved in across the street from Alaska in just the past few years who have very good merchandise and offer better terms. He advised ARCO Alaska wants to stay shopping in Alaska and believes by gathering this information and working together, a regime can be developed which will be acceptable to the citizens of Alaska and will keep ARCO Alaska shopping in the state. MR. THOMPSON said once the information is gathered, it is recommended that a broad range of options be developed, which can be narrowed to specific proposals for legislative action, perhaps at next session. He stated the immediate steps he talked about earlier, which could improve existing incentives and regulations, could be done in the next few months. He stressed the long term recommendations are more complex. These steps say ARCO Alaska wants to compete in Alaska versus these other countries. REPRESENTATIVE EILEEN MACLEAN asked Mr. Thompson what type of options was he talking about. MR. THOMPSON responded the options could be long term things he talked about earlier such as net profits type of recoveries versus a fixed royalty or things such as a variable royalty. MR. THOMPSON commented on an option ARCO Alaska is not recommending at this time, but one which shows creativity and a way of addressing some of the issues being faced when making competitive investments in Alaska. He said, referring to the next option, that ARCO Alaska has listened to the concerns about changes regarding the permanent fund. ARCO Alaska believes this option would work to protect that fund. He explained where there are zeros now on marginal fields, this option could create positive values for the state, the industry, and the permanent fund but also could provide a floor on permanent fund contributions which is a sensitive issue. Number 543 MR. THOMPSON explained this option is called a conceptual fixed- variable royalty which means fixed for the permanent fund and variable for the industry to make investments competitive. He said the royalty percentage side of the chart has not been filled in yet and felt the numbers should be filled in over the next few months by the joint work earlier talked about. He pointed to another line which would vary according to oil price. For example, if oil prices are high, the royalty should be higher and perhaps the state's share even higher than what it is currently under existing royalties. MR. THOMPSON stated there is a realization of the sensitivity present if industry gets breaks on incentives on small fields--for example if a company goes out hunting for a 50 million barrel field and it turns into a billion barrel field. He said the royalty could easily be tied to field size. In the example, a higher royalty should be involved because the company would get a good return on its investment and the state should share even more. He stated well productivity plays a key role in driving the industry's economics and making investments. MR. THOMPSON said currently on leases (past 1979), 6.25 percent of the royalty goes to the permanent fund. He explained under this option, that would be fixed for the permanent fund and then it would only vary and track 50 percent as the royalty varied tied to higher oil prices, productivity, or field size. He emphasized this is just one option. Some of the options of net profits and other types of royalty variance actually could do similar things and attract investment. MR. THOMPSON said the best option is one worked out by the industry, the Administration, and the legislature together and then is accepted through a public process. REPRESENTATIVE MACLEAN wondered if she could ask a question. CO-CHAIRMAN GREEN said he would prefer that Mr. Thompson be allowed to go through his presentation and then questions could be asked following that presentation. Number 577 MR. THOMPSON noted that whatever the new tax royalty regime is decided for Alaska for new projects, there may still be projects on the noncompetitive margin. He said for those projects where the state's new changes are not enough, ARCO will propose a project partner approach. In this approach, ARCO would come forward with information shared openly and then the state would decide if this partner project would be sufficient to meet the approval for moving forward. He pointed out that ARCO has looked at potential categories for the project partnering process. MR. THOMPSON stated one category is new marginal exploration and an example is Lease Sale 79. ARCO recently sent a letter to DNR suggesting more of a partnership in approaching Lease Sale 79. This would get all parties involved much earlier in a public process to innovate using existing laws and options that would make Lease Sale 79 prospects even more internationally competitive. He said another category is marginal development, new field. He noted that ARCO is drilling the West Colville Delta currently and is hoping the well results are good enough for ARCO to move forward without any incentives. On the other hand, if ARCO has disappointing well results, and since it is a smaller field discovery, ARCO questions if it would be possible to work together to innovate what it would take for the jobs and revenue to come from it. MR. THOMPSON said another category is marginal development, existing field such as West Sak, a huge resource. He assured committee members that ARCO has pieced together technical and research teams to try to innovate to reduce costs and move forward on the West Sak. He stated if the cost reductions are not enough, then, and only then, would ARCO come forward for a project partnering. He noted another category is fields near abandonment which ARCO does not have. He pointed out that Cook Inlet and Kenai producers do have fields near abandonment that perhaps would be amenable to project partnering. MR. THOMPSON stressed, in regard to earlier overheads on immediate actions and steps to be taken on the long term, those changes may mean that ARCO can move forward without project partnering. He stated if those changes are not enough, ARCO believes it is a resource base that should be brought forward and the state should be allowed to look at it in a very open process (with ARCO) to see what it will take to move forward. Number 622 MR. THOMPSON said the question may be asked, is what other countries are doing working? He stated the UK was a country where production was on the decline, about one and one-half million barrels a day, similar to Alaska. He noted the UK's revenues were declining significantly and jobs in the industry were declining causing other jobs in the industry to also decline. In the 1980s and more recently, the UK has completely changed their philosophy to attract more capital. MR. THOMPSON stated the UK did have a corporate income tax at 52 percent and to attract new investments, they lowered it to 33 percent. The UK had a royalty of 12.5 percent similar to Alaska. In 1983, the UK completely eliminated the royalty. At one time, the UK had a supplementary petroleum duty which was eliminated. The UK had a petroleum revenue tax that was 45 percent and as high as 80 percent on some properties. This tax was very similar to Alaska's severance tax. The UK has now eliminated that tax also. Therefore, in the UK, when looking at capital investments in the oil and gas industry, there is only one taxation royalty--33 percent corporate income tax which compares to Alaska's 39 percent federal and state income tax, severance tax of 0 to 15 percent, royalties of 12.5 percent, and ad valorem tax of 2 percent. Number 647 MR. THOMPSON said the question becomes, did these changes work in the UK? After the changes in the 1980s, industry did respond. He showed an overhead showing capital expenditures. He stressed since UK's changes, $45 billion of new investment has come into the country and most of that investment is in small to moderate sized fields. He stated since the changes, there have been 23 new fields on production since 1985 and 12 other new fields will come on line this year alone, which is a total of 35 new fields. He pointed out that in Alaska since 1985, four new fields have come on line. MR. THOMPSON stated in regard to the UK production profile--in the beginning of the 1990s, the old fields were producing about 1.5 million barrels per day. With the changes, the production has gone from 1.5 million barrels per day to over 2.5 million barrels per day. He pointed out that in December, the UK hit a record high production level for the entire history of their oil and gas industry. MR. THOMPSON said this can be done in Alaska if immediate actions are taken to strengthen existing regulations and incentives. He stressed if some of the long term actions are taken and if the legislature, industry, and the Administration work together, he felt something similar can happen in Alaska. He noted he does not believe the same steps that UK took should be taken in Alaska. Rather, there is a need to come up with recommendations that will be acceptable to the people of Alaska, the legislature, the industry, and the Administration. TAPE 95-16, SIDE B Number 000 REPRESENTATIVE MACLEAN asked how a fixed-variable royalty would impact the state. MR. THOMPSON replied (referring to an overhead) if the state accepted the fixed-variable royalty, the permanent fund contribution would stay the same and the state's share would be above the shaded line. It is hoped that this would allow more smaller and moderate sized fields to be developed and where those may be zero revenues now, there would be positive revenues. He stressed if exploration or further delineation in development results in very large fields, it could be a higher royalty for the state than what currently exists at the 12.5 percent. REPRESENTATIVE MACLEAN wondered if the project partnering is already in place with different companies. MR. THOMPSON responded ARCO does have partnering projects in place with many of its service suppliers and contractors. They have sat down together, talked about the trust and communication desired and about common goals on how to reach cost saving targets. He said ARCO has a partnership with the state of California at the Long Beach unit. In that partnership, the existing royalties would not make new work there commercial. Therefore, ARCO worked with the state to develop a net profits type of concept. Once the California State Legislature approved that, ARCO moved forward with $100 million of new investment, resulting in a new 100 million barrels of oil in an old field that was 5 years away from abandonment. He noted that all of ARCO's projects in China are partnerships. In Indonesia, ARCO has a production sharing contract. MR. THOMPSON stated ARCO is encouraged by recent discussions they have had with DNR and giving input on Lease Sale 79, including what options are available to them. REPRESENTATIVE MACLEAN questioned what type of incentives is ARCO looking for from the state for marginal exploration and development. MR. THOMPSON responded near term would involve reenforcing and clarifying existing regulations and having ARCO's technical teams work with the various commissions' technical teams to determine how those regulations could be clarified or changed slightly and then come forward with legislation. In the long term, he felt it is going to take ARCO's technical teams working with the commissions' technical teams examining some of these other royalty regimes and tax regimes, determining what might be best for Alaska long term and suggesting legislation for next session. REPRESENTATIVE MACLEAN agreed that some existing regulations need to be changed, especially for the near term. She stated in regard to ad valorem taxes, what does ARCO recommend the state pursue in new field development. MR. THOMPSON stated ARCO has not looked at the details to determine if that tax should change. He said for some fields near their economic limit, if the ad valorem was reduced, it would extend the field life. ARCO does not have a proposal to do that nor does ARCO have uneconomic fields at this time. He felt that tax change could be looked at for Cook Inlet or Kenai producers. He noted he is not aware of any proposals to change ad valorem taxes at this time. REPRESENTATIVE MACLEAN recommended that ARCO look at that proposal. REPRESENTATIVE JOHN DAVIES recalled that Mr. Thompson had mentioned Alaska's corporate income tax is 39 percent, which is a combination of federal and state. He asked what the proportions are. MR. THOMPSON replied Alaska has the 9.4 percent and then when the federal is completed, a deduction is received by having paid the state income tax, similar to what individuals have. He said the combination is around 39 percent. REPRESENTATIVE DAVIES clarified the state is not on the smaller end. MR. THOMPSON answered that is correct. He said in addition, the state has a 12.5 percent royalty, up to 15 percent severance tax and 2 percent ad valorem tax. REPRESENTATIVE DAVIES recalled that Mr. Thompson had mentioned there were some items he was concerned about in regard to developing a more flexible regulatory environment, again focusing on smaller new fields. He asked Mr. Thompson to give some examples of things which might help industry. MR. THOMPSON said one example is Lease Sale 79. There are different options under existing laws that allow the commissioner to choose lease sale terms. The commissioner could choose a high bonus and a fixed royalty, for example, or he could choose low bonus and a net profits type of interest that would be shared with the state. When that option is looked at, areas become much more competitive with the international environment. He stressed technical teams are looking at the economics in regard to those laws, where the commissioner has flexibility in determining what would make the sale more competitive with foreign exploration and trying to get more dollars to Alaska. MR. THOMPSON stated another example involves fields not close to existing facilities. He said it takes 100 million to 300 million barrels to be economic. Allowing some flexibility in the royalty that could be granted by the commissioner would be helpful. Number 165 REPRESENTATIVE DAVIES stated those examples are more in the line of incentive and tax royalty structures. He said his question was geared more toward regulations. He asked if there were specific regulatory types of things he was concerned about. MR. THOMPSON stated there are. He mentioned the Alaska Oil and Gas Association is beginning a project to look at what could be some changes to make regulations and the process more effective. He gave an example on something the industry has faced. The industry reports very diligently any minor spills of any fluids. When a minor spill happens, the industry has to phone different agencies and the different agencies have different forms to complete. He said an idea was a 1-800 number that would be called, then the other agencies would be notified of that specific spill and there would be just one form. Therefore, the people involved could spend all their time and effort on effective cleanup and remediation versus the regulatory paperwork and administrative burden. REPRESENTATIVE DAVIES recalled that Mr. Thompson had mentioned that some of the exploration incentives put into place last legislature are not working and that ARCO had applied for three wildcat wells and was turned down. He asked why ARCO was turned down. MR. THOMPSON stated ARCO had included three exploration wells in its exploration budget and plans. He stressed there is a lot of discretion on how that incentive credit is to be applied and a lot of judgment by members within the Oil and Gas Commission and DNR. He said it is not clear when you can get the incentive. ARCO applied in every case and then had discussions on whether or not the well was appropriate and would it qualify. He noted the applications involved North Slope exploration wells and one Cook Inlet exploration well. ARCO felt the wells did apply, but as it turned out they did not. He said what ARCO is suggesting is the possibility of doing something as simple as defining the incentives and determining if a well is an exploration well under IRS or SEC guidelines. He stressed the state still would have a cap on the number of credits given every year and when that cap is reached, the credits would stop. Number 229 REPRESENTATIVE DAVIES said there was much discussion when the exploration incentive credits were being debated about how to define a new field versus a continuing of an existing field. He asked if the three cases were in that gray area. MR. THOMPSON stated in some cases, ARCO felt it was very clear a new field was involved. In others, it could be argued it was an extension of an existing field, although ARCO felt it would be a different area--a new area that would not be recovered from existing fields. He stressed it would be helpful to clarify that gray area in existing regulations. CO-CHAIRMAN GREEN expressed concern that if in order to justify one or more of these incentives it would require the applicant show a lot of both subsurface and economic criteria that heretofore has been very confidential. He clarified that Mr. Thompson was saying that companies would in fact be willing to make this information available to the extent necessary. He expressed concern about the information being made available and either the state does not accept it or there is a delay to the point where a company does not make the investment. However, this information is now public. He asked if ARCO believes there is enough impetus to provide this confidential information to get incentives that companies might be willing to make those commitments. MR. THOMPSON stated he can only speak for ARCO and ARCO is willing to provide the information. ARCO is ready for a true partnership with the state that would involve the allowing and sharing of more information so it can be interpreted together. He said he has seen it happen in other countries and it is very rewarding to work together and move forward with development. He noted what is happening now could be a higher risk such as job layoffs, greatly reduced exploration budgets, etc. ARCO believes that when they turn over any information, the commission will adhere to the current confidentiality regulations. MR. THOMPSON said in preparation for Lease Sale number 79, in working with the Alaska Oil and Gas Conservation Commission (AOGCC), ARCO shared maps and seismic sections that have never been shared before. ARCO wanted to verify its own interpretation that area would be small to moderate sized fields and if there was oil there, to illustrate there is a chance of discovery so that these more flexible terms under existing law could be applied. He stressed that ARCO realized it was taking a risk to share much of that information but trusted the individuals involved. ARCO also realized that if the information was not shared there may be no loaf instead of one-half a loaf. Number 306 CO-CHAIRMAN GREEN thought when the word partnering is used, it conjures up both or multiple partners becoming investors as well. He clarified that Mr. Thompson was not anticipating the state actually putting up financing. MR. THOMPSON said it was partnering through what the state receives. He noted if the state wants to invest, that is its decision. CO-CHAIRMAN GREEN said in determining the economics of a project and whether or not it would qualify for an incentive, what would be of paramount interest is the anticipated operating and investment expenses. He said let us suppose we were on a net profits lease. If the state went along, would the state be a party to determining how much is enough? He expressed concern that if two units could do the activity but three units of costs are projected, the state would say yes because it extends out the life before the net profits start to kick in or reduces the amount of net profits which would come back to the state. He asked if the state would have any ability to make suggestions or have any control in regard to expenditures. MR. THOMPSON replied in the state of California where ARCO had the partnership on the Long Beach unit, the state was involved in defining what costs were appropriate and what other expenses would not be appropriate. Those categories were defined and yearly, the state audits ARCO's costs to ensure it has complied with what was in writing as qualifiable costs. He felt that could be done in this case for net profits. He noted there may be an administrative burden in doing that--things such as the conceptual fixed-variable royalty may get the same result without that kind of burden of administration. He stressed that is what needs to be worked through in the next few months. MR. THOMPSON added that under net profits, it does behoove both the operator and the state to keep the costs as low as possible. REPRESENTATIVE MACLEAN asked Mr. Thompson to further discuss the discovery royalty credit. MR. THOMPSON stated the discovery royalty credit provides that a lessee, who makes the first discovery of oil or gas on a structure, pays a royalty of 5 percent for 10 years following the date of discovery, and then 12.5 percent royalty thereafter. He stressed it is only on that lease. He said there would be other leases in the field. He noted a simple idea--on the other leases, the discovery royalty should be allowed but maybe have it for only five years. REPRESENTATIVE MACLEAN clarified that one of the options is to extend the time period. MR. THOMPSON replied ARCO has not looked at extending the time on the discovery lease beyond ten years. REPRESENTATIVE MACLEAN asked what ARCO's recommendation would be. MR. THOMPSON said it is an area which needs to be reviewed by ARCO's technical teams working with the commission to determine what might be appropriate. He stated something as simple as having a few years could have an impact but the exact recommendation should come from the technical teams. Number 378 CO-CHAIRMAN GREEN stated ARCO is not actually advocating specific options but are suggesting various options. He added exploration royalty reduction has been in effect in the state and was repealed a short time ago. He said this is not a new concept but what ARCO is referring to is perhaps the leases adjacent to the discovery lease. MR. THOMPSON stated on behalf of the employees of ARCO Alaska, he would like to thank the committee for the opportunity to share ARCO's ideas. Number 390 JAMES PALMER, DIRECTOR, EXTERNAL AFFAIRS, BRITISH PETROLEUM EXPLORATION (ALASKA) INC. (BP), stated "given our common challenges and shared opportunities as an industry and as a state, it is particularly fitting that we're gathered here together to explore how we can work together to attract new industry investment to Alaska. BP is pleased to be a part of this new dialogue, which we hope will lead to a new era of cooperation between state government and the state's largest investors and taxpayers." MR. PALMER said, "Our industry has gone through an extended period of unprecedented change--often painful--to arrive at our current crossroads. We've experienced downsizing, rightsizing, restructuring, realignment, outsourcing, alliancing, shared services, streamlining, technological breakthroughs and countless other innovations and upheavals in the way we do business in order to remain competitive in the global market." MR. PALMER stated, "As a result, we've been able to reduce costs in a climate of declining production, we've been able to hold overall production decline on the North Slope to less than five percent per year. We have been able to hold decline to these levels only by continuing to invest in new and existing fields on the North Slope. This year we plan to invest more than half a billion dollars of capital in Alaska, successfully competing within BP for those funds. These investments generate jobs for Alaskans and revenues for Alaskan businesses. They help to sustain the flow of revenues that fund state government spending and fuel future investments in the Alaskan oil industry. They extend the lives of our North Slope operations, and they hold one of the keys to Alaska's economic future." MR. PALMER continued, "Despite our best efforts within the industry, however, we remain under siege from a variety of forces undermining our efforts to attract additional investments to Alaska. In real terms, the price of oil has been on a downward trend for the past 15 years. This, combined with declining production in Alaska, has slowed the flow of revenues that fund future investments. At the same time, a world of new investment opportunities--literally as well as figuratively--has been opening up to the oil industry due to falling political barriers, new technologies and friendlier relationships with many host governments in oil provinces around the world. In this global environment, companies are limiting the scope of their activities and becoming increasingly selective in choosing which projects to pursue. Investments are directed to areas offering the highest returns with the lowest risks." MR. PALMER stated, "Alaska is disadvantaged in this fiercely competitive environment for increasingly scarce investment capital due to our remoteness, our high transportation costs, our restricted markets, a state budget deficit that casts a cloud of uncertainty over all of our investments and a history of antagonism between industry and the state. Furthermore, the opportunities that do exist on the North Slope consist of marginal new oil fields or marginal projects within existing fields." MR. PALMER said, "The first step toward capturing the significant potential for new investments, revenues and jobs in Alaska in this emerging era of marginal development on the North Slope is redefining "us and them" to mean Alaska's unity as we compete globally for increasingly scarce investment capital rather than our divisiveness as we fight among ourselves. It is imperative that we work together to take tangible steps today toward a strong and stable industry, toward a strong and stable Alaskan economy tomorrow." Number 445 MR. PALMER continued, "We are encouraged that the legislature is taking initiatives such as your hearing today to provide forums for the dialogue that will enable us to work together to develop win- win solutions to our common challenges. We are also encouraged that the Governor has made unity between government and business a theme of his new Administration and has reinforced his words with his actions since he took office. The progress the state of Alaska and BP have made in the past year working cooperatively to lift the federal ban on North Slope oil exports is testimony to what we can accomplish together. Ending the ban will truly be a win-win outcome that will both enhance the flow of revenues to producers and the state and enhance the competitiveness of Alaskan investments." MR. PALMER stated, "Resolution of significant past tax disputes during 1994 have improved the investment climate in Alaska. We can now focus our efforts on the future without looking over our shoulders at liabilities of the past. Recently enacted tax regulations have helped to clarify how to value oil for tax purposes for companies that refine their own oil. However, the same vagueness that led to past disputes continues for companies like BP that sell or trade the oil they produce on the North Slope. Vagueness equals uncertainty, uncertainty equals risk, and risk equals competitive disadvantage in our efforts to attract capital to Alaska." MR. PALMER said, "Tax clarity for all producers would reduce our risk and would be a significant win for us and a significant win for the state. By helping to minimize our risk, you can strengthen our position to compete for investments that will benefit us all. The fiercely competitive global environment in which we operate makes it an uphill struggle, and the marginal nature of projects we have to pursue on the North Slope makes the hill even steeper. We in BP and in the oil industry are doing all we can to compete for these investments." MR. PALMER told committee members, "Consider the Badami discovery about 30 miles east of the producing Endicott field on the North Slope. This field is typical of the projects in the 100 to 150 million barrel range we expect will be developed over the short and medium terms. The first hurdle we must clear is confirming the size and quality of the reservoir. We are currently drilling two appraisal wells and hope to have the results assessed by this fall. We believe Badami must hold at least 100 million barrels of recoverable oil in order to have a chance to make it commercially viable. If we clear that hurdle, we are still a long way from having a project. When we first began to evaluate Badami about a year ago, we identified four primary obstacles: It was too costly, there was too much time between discovery and production, there were time consuming regulatory roadblocks, and there was no hedge against the risk of low prices. All four still remain, and we've been doing everything within our power to overcome them." MR. PALMER stated, "The cost hurdle is enormous. Our initial projection of the development cost, based on doing things the old way, was $800 million. We must reduce the pricetag by more than half in order to enable Badami to compete effectively for development funding. In our effort to reduce costs without comprising safety or the environment, we have considered a myriad of innovative development techniques--a buried, chilled pipeline, facility sharing and remote operations, to name a few. We have also assembled a team of key contractors who are working with us to find solutions to the cost challenge." MR. PALMER explained, "Traditionally, we would be waiting for the results of this winter's wells before taking this step. However, traditions that have evolved over the past two decades of North Slope oil field development will not overcome the challenges posed by the marginal development opportunities of the future. Timing is crucial, and it is imperative that we shorten the period between discovery and production. That is why we have assembled contractors now rather than later and asked them to work together as a team. It is also why we initiated discussions with state, federal and borough regulators months ago instead of later, then we filed for permits." Number 512 MR. PALMER said, "This approach unquestionably adds to our up-front risk. We understand there are no guarantees, but it is a risk we believe we must assume in order to have a chance to make this project viable. We also believe it will help to incorporate the best ideas into the planning process, and we hope it will help to resolve official and public concerns about the project and help to expedite the permitting process. There is one other risk that we must manage, and that is the risk of low prices. That is why we are interested in a sliding-scale royalty for Badami that would be sensitive to oil prices. This would help to minimize our risk exposure to low prices, and it would enhance our prospects for making development commercially viable." MR. PALMER stated, "The sliding-scale royalty concept would enable us to share the risks of low prices and the rewards of higher prices with you, our co-beneficiary, if you will, in having Badami developed. Badami is neither competitive nor commercially viable today. Our shared goal with the state of Alaska must be to make it competitive and commercially viable so we can share the benefits of the production, the revenues and the Alaska jobs the project would generate. If we are to work together to successfully attract investments to Alaska, we must all be flexible in approaching the challenges and opportunities posed by each new project. We believe this suggests a broader discussion in the legislative arena of the use of royalties as a development incentive tool." MR. PALMER told committee members, "We believe it is appropriate for the legislature to consider giving the commissioner of Natural Resources the authority to adjust royalty terms on new developments on a case-by-case basis if changes are needed in order to make a project viable. Some of the criteria that might be considered in reviewing royalty terms are: Does the project need a major cost breakthrough in order to be competitive? Even if it overcomes the initial cost hurdle, will it still be vulnerable to low oil prices? Could it bring jobs and new technology to Alaska? Could it make other exploration, appraisal or development projects more attractive?" MR. PALMER stated, "We are not suggesting that flexible royalty terms are necessary--or even appropriate--for every project. But to the extent that they can be used to enhance the competitiveness of projects whose funding otherwise might go elsewhere, it is important that the state have the tool available and ready for use. Whether to grant flexible royalty terms--and what kind--will be a judgment call on the state's part. It will be incumbent on companies like BP that are seeking them, therefore, to be completely open and forthcoming with the information state regulators need in order to make that determination. Only then can we deal with each other in an honest and collaborative manner and work together toward our common objective of securing new investments." MR. PALMER stressed, "This is not the time for demands. It is not the time for threats or hollow promises, and it is not the time for brinkmanship or posturing. It is the time, if we are truly committed to working together to capture Alaska's share of industry investments, for constructive, open, productive dialogue such as we are having today that leads to win-win solutions for the industry, for state government, and for all Alaskans. I pledge BP's complete, unconditional cooperation and support in this endeavor. Thank you." Number 545 REPRESENTATIVE MACLEAN recalled that Mr. Palmer had talked about tax clarity. She wondered what type of tax clarity he was referring to. MR. PALMER responded BP's past disputes, to a large degree, involved a debate over what was the value of the oil when it was sold. The regulations recently enacted set tax clarity for producers who refine their own oil. He said a mathematical calculation was done and this was called the prevailing value. If a company paid its severance tax based on that prevailing value that was assumed correct, similar to the current process for royalty payments. He stated BP is seeking the same treatment for sales of crude oil, which would give them certainty so when they pay a severance tax today, they know that is the payment and there will not be a debate with the state years from now over whether or not that payment was correct. REPRESENTATIVE MACLEAN asked Mr. Palmer to further explain the sliding-scale royalty concept. MR. PALMER said BP has had good discussions with the department regarding the sliding-scale royalty concept and the discussions revolved around risks of low oil prices. The discussions centered around the sliding-scale royalty based on oil prices--there would be a base amount of royalty and a ceiling. In between, there would be a sliding scale and the royalty rate paid would be based on what the price of oil was. REPRESENTATIVE MACLEAN wondered if the sliding-scale royalty would be used on marginal fields also. MR. PALMER responded yes and added this concept would be most appropriate for individual projects. He noted the state would make a decision on each individual project. He said there is a question as to whether or not the state has the authority to grant such a sliding-scale royalty and attorneys are saying different things. REPRESENTATIVE MACLEAN clarified it would have to go through the legislative body. MR. PALMER responded legislative clarification of the authority of the commissioner would be warranted. Number 579 CO-CHAIRMAN GREEN noted that Mr. Palmer had mentioned Prudhoe was declining at upwards of 15 percent, but through other investments and other fields, BP had been able to lower the overall decline to 5 percent. He asked Mr. Palmer to explain the severity of what a 15 percent decline rate would mean over a 5 year period. MR. PALMER responded he would be happy to bring forward people who could speak to that question more knowledgeably than him and added the producers could provide that information in detail. He added that Prudhoe did decline but Point McIntyre is performing very well. CO-CHAIRMAN GREEN clarified even with these other fields coming on line, it is still not possible to offset the decline of such a major field like Prudhoe. MR. PALMER said that was correct. CO-CHAIRMAN GREEN clarified that Mr. Palmer subscribes to the same general philosophy given by ARCO--looking at a variety of potentials that would help BP invest in Alaska as opposed to going to the world market. MR. PALMER replied yes. He stressed BP agrees with everything Mr. Thompson said and looks forward to working with ARCO and other producers in Alaska as well as the state. Number 604 CO-CHAIRMAN GREEN asked if incentives or packages were enacted by the state, is there a possibility of re-energizing some of those companies who have left Alaska. MR. PALMER said he could not speak on what other companies would do. As an Alaskan, he would hope those companies do come back as it is important for those who live in the state to have a very vigorous oil industry. He stressed it is imperative that the state have additional participants in the industry. REPRESENTATIVE DAVIES recalled that most of the discussions revolved around new oil discoveries. He asked Mr. Palmer to comment on the potential for gas development. MR. PALMER responded there is a huge resource of natural gas on the North Slope. He said that resource has been around for a long time. He noted that all of the producers on the North Slope are looking to commercialize that resource. The question remains under what terms can they get a good economic recovery from it. He pointed out the three companies who are looking at that resource are engaged in a major effort to look at opportunities to market that gas. At this time, he could not comment on specific plans. CO-CHAIRMAN BILL WILLIAMS wondered if the industry was to receive everything they are asking for, how long would Alaska be competitive in the oil industry. MR. PALMER responded since he lives in the state and wants his children to stay, he hopes the state will remain competitive for a very long time. He said the world changes and the group gathered may be having another discussion in 10-15 years but he felt as long as the state can remain competitive, which may mean different things in different periods of time, the state will have a viable industry. He stressed flexibility is very important. CO-CHAIRMAN WILLIAMS stated partnerships have been previously discussed. He said the oil is owned by the state of Alaska, similar to the logging industry where village corporations own the timber. He noted that some village corporations have sold their timber outright and took it for stumpage sale. Other corporations went and took the risk and contracted out the logging. He wondered if that could be done in this situation. TAPE 95-17, SIDE A Number 000 MR. PALMER responded the legislature has the authority to do that. He said there are many countries in the world who do it that way. Whether or not a company would decide that it is in their economic interest to enter into such an arrangement versus the current arrangement would have to be looked at to make sure there are people interested in doing such an arrangement. REPRESENTATIVE ALAN AUSTERMAN recalled reading about a large natural gas field off Africa or Indonesia which industry is in the process of developing at this time. He wondered if BP is able to spend hundreds of millions of dollars over there to pull a lot of gas out of the ground and sell it as compared to Alaska due to the structure of the tax basis here and what it costs to do business in Alaska. MR. PALMER stressed BP is not involved in that project which is in Indonesia. He explained his understanding is that it is not a project yet but rather, the producers have entered into an agreement with Indonesia to look at a project. He said it is a similar situation as to what is in Alaska--the resource is there and the producers are trying to make it commercially viable. REPRESENTATIVE AUSTERMAN stated in general terms, the economics in that part of the world must be better than what they are in the state of Alaska. MR. PALMER said he could not comment on it because he does not know the particulars. CO-CHAIRMAN GREEN asked if there were any other questions. He thanked Mr. Thompson and Mr. Palmer for their presentations. He stated the legislature looks forward to working with them both during this session and during the interim. REPRESENTATIVE MACLEAN noted for the record that she is going to chastise Co-Chairman Green for his committee process. She felt committee members should have the freedom to ask questions during the discussion because it is very important for members to understand oil and gas related matters, especially when the matters concern her district. CO-CHAIRMAN GREEN said he would talk to Representative MacLean after the meeting about the matter. ADJOURNMENT There being no further business to come before the House Resources Committee, Co-Chairman Green adjourned the meeting at 9:35 a.m.