JOINT SPECIAL COMMITTEE ON MERGERS September 25, 1999 3:30 p.m. MEMBERS PRESENT Senator Rick Halford, Chair Senator Drue Pearce Senator Johnny Ellis Representative Joe Green, Vice-Chair Representative Brian Porter Representative Beth Kerttula MEMBERS ABSENT Representative Jim Whitaker OTHER LEGISLATORS PRESENT Senator Mike Miller Senator Loren Leman Senator Kim Elton Senator Lyda Green Senator Robin Taylor Senator John Torgerson Senator Lyman Hoffman Senator David Donley Senator Jerry Ward Senator Gary Wilken Representative Allen Kemplen Representative John Coghill Representative Sharon Cissna Representative Tom Brice Representative Hal Smalley Representative John Davies COMMITTEE CALENDAR British Petroleum-ARCO Merger Executive Session: Legislative Briefing PREVIOUS ACTION See the Joint Special Committee on Mergers minutes dated 6/11/99, 7/28/99, and 9/24/99. WITNESS REGISTER BRUCE BOTELHO, Attorney General Department of Law PO Box 110300 Juneau, Alaska 99811-0300 Telephone: (907) 465-2133 POSITION STATEMENT: Offered to answer any questions. JOHN SHIVELY, Commissioner Department of Natural Resources 400 Willoughby Avenue Juneau, Alaska 99801-1724 Telephone: (907) 465-3886 POSITION STATEMENT: Spoke to the Administration's view on the issues brought forth by BACKBONE. Answered questions. FRED BONESS, Attorney Preston, Gates & Ellis 420 L Street, Suite 400 Anchorage, Alaska Telephone: (907) 276-1969 POSITION STATEMENT: As outside counsel for the committee, he provided the committee with information and answered questions. JOHN MESSENGER, Attorney Preston, Gates & Ellis 420 L Street, Suite 400 Anchorage, Alaska Telephone: (907) 276-1969 POSITION STATEMENT: Discussed the tax structure. ACTION NARRATIVE TAPE 99-6, SIDE A Number 001 [NOTE: This meeting is technically a continuation of the September 24, 1999, meeting which was recessed to the call of the chair.] CHAIRMAN HALFORD called the Joint Special Committee on Mergers meeting to order at 3:30 p.m. Committee members present were Senators Halford, Ellis and Representatives Green, Porter, and Kerttula. Other Senators present were Senators Miller, Leman, Elton, Green, Taylor, Torgerson, Hoffman, Donley, Ward, and Wilken. Other Representatives present were Representatives Kemplen, Coghill, Cissna, Brice, Smalley, and Davies. BRUCE BOTELHO, Attorney General, Department of Law, expressed his apologies that he has been summoned to another meeting. Therefore, Commissioner Shively is prepared to speak to the BACKBONE issues on behalf of the Administration. Attorney General Botelho also expressed his desire to continue to work closely with the committee and the legislature with regard to the state's best interests in the merger. He offered to answer any questions. Number 032 JOHN SHIVELY, Commissioner, Department of Natural Resources, expressed the need to recognize that the state could have chosen a variety of venues in order to review this merger. The state could have worked under the assumption that the merger would have been approved, leaving BP as the single largest player. The state instead took the route to obtain divestiture in order to maintain a competitive force on the North Slope as well as other parts of the state. Commissioner Shively pointed out that with that approach one must recognize that one can't fix every problem in the oil industry. He said, "The key becomes divestiture, the key becomes having another strong operator on the Slope against which we contest things like pricing, like how they do business with Alaska, like how they treat the environment, like what they're doing with technology." COMMISSIONER SHIVELY acknowledged that some, such as BACKBONE, suggest that the state should bring a suit in court. Although there are issues beyond divestiture which are important issues, he believed, personally, that in court the state would face only the anti-trust issue. Such a situation would probably result in only one solution which he identified as divestiture. He mentioned that in such a situation a number of the other issues would automatically be taken off the table. Commissioner Shively turned to the issues attached to the letter from BACKBONE. The first issue listed is the wellhead value. He stated that the settlement agreements provide some ability to revisit the wellhead value on a regular basis. Therefore, there is some protection. He wasn't sure it is appropriate to establish a particular approach for BP since there will be another operator. Internally, there is regular discussion with regard to whether the reopeners should be activated. He believed that even with divestiture there is some danger that values would change. He didn't believe that every valuation problem would be fixable as part of the negotiations. Commissioner Shively turned to the issue of competition. The state, the Governor, and BACKBONE all seem to be in agreement that there needs to be a strong operator. With regard to access to TAPS and TAPS tariffs, the Governor has realized that high tariffs are potentially a barrier to competition. However, he acknowledged that the state negotiated an agreement in good faith. He commented that TAPS and TAPS tariffs continue to be an issue of discussion with BP. COMMISSIONER SHIVELY turned to the issue of access to facilities and infrastructure on the North Slope which is important even with divestiture. He stressed that virtually no one is a single owner of infrastructure. All fields built involve a number of oil companies. For example, the Alpine field is owned by ARCO and Anadarko. If someone wants access to the fields both companies would have to agree on the fees. In a location such as Prudhoe, where there are multiple owners, the situation becomes more complicated. Therefore, no single company can set those fees. However, internally there has been the view that the state has some authority over these issues if companies can't resolve such issues. Although there have been a number of disagreements on the Slope, to his knowledge there hasn't been a situation in which oil wasn't developed due to disagreements over fees. As part of the state's ability to manage units, he believed the state could say that oil has to be developed. Commissioner Shively recognized that this is a complex issue because it isn't just access or money, the issue also involves capacity. However, this issue is on the task force's list. COMMISSIONER SHIVELY said that natural gas is also on the task force's list. The Governor has been clear that if there is a viable project, the gas should be made available. He pointed out that BACKBONE had expressed concern that if there was a gas to liquids project, the state would receive no value for its gas. He, as commissioner, said that he had never been under that impression. If people use Alaska's gas, there will be a value to it. To his knowledge, no one has ever suggested that there would be a zero royalty. This Administration has always made it clear that they believe there is a value which they intend to obtain. Certainly, tax policy on natural gas can be utilized to promote various things. Commissioner Shively offered to answer any questions. Number 153 SENATOR TAYLOR understood Commissioner Shively to say that access to processing facilities would be dependent upon consent from the owner or owners. He also understood Commissioner Shively to say that if the owners of such facilities were unable to achieve an agreement with the new entrant, that Commissioner Shively had the authority to step in. In those negotiations, who would protect the State of Alaska? COMMISSIONER SHIVELY replied no one. He explained that he didn't believe those costs are deductible. The facility costs are between the industry. For instance, if Company A tries to enter and Companies B, C, and D charge too much, Company A would pay, not the state. SENATOR TAYLOR asked if that would impact the production, should the company fail to produce based on too high of a rate. COMMISSIONER SHIVELY said that is the issue. He reiterated that, to his knowledge, no oil has failed to be developed because of owners not coming to an agreement on the use of facilities. If the owners did end up in disagreement, then the state should come in and state that the oil should be developed. SENATOR TAYLOR posed the assumption that the state receives back some oil leases which are made available. In such a case, what could the potential purchaser of a lease rely upon with regard to access to facilities? COMMISSIONER SHIVELY didn't view that situation as any different than the current situation. He wasn't sure that if there is competition, that it would change. Furthermore, not all fields need access to other facilities. He believed that there needs to be comfort for those who need facilities, in that the state would have the ability to review that. With divestiture, Commissioner Shively didn't really see a change from the current situation. Number 207 CHAIRMAN HALFORD said that he understood the law and regulations to clearly provide that one can eliminate a fractional interest in 300,000 or 400,000 acres while maintaining absolute majority control of 800,000. He understood that would comply with the law's 500,000 acre requirement. What will be done and how will it be done? COMMISSIONER SHIVELY commented that there are discussions with BP regarding how the divestiture in acreage would take place. Currently, BP and ARCO have bid with other partners who generally have preference right if BP or ARCO wants to sell their portion to buy in at whatever someone else offers. That is an issue that must be dealt with. They may not have total control as to who they sell to. There have been discussions, which he wasn't prepared to discuss in public at this point, regarding how to assure one could obtain control of definite prospects. Commissioner Shively commented that BP wouldn't be able to have a controlling interest if there are other operators. Ultimately, if BP doesn't meet the requirement, they can be given a 90 day notice which must be completed in 90 days or the lease reverts back to the state. SENATOR PEARCE recalled that at yesterday's meeting, Attorney General Botelho said that the Governor wants to ensure there is a second operator on the North Slope. Does that mean a new entrant coming in to operate new fields that aren't presently produced? Or, is the desire to merely have a second operator on the North Slope? COMMISSIONER SHIVELY said that he believed the Governor has made it clear that there has to be actual transfer of production. Therefore, the new company or companies would have some production from what is ongoing. Equally as important, would be decent exploration acreage. He explained that no one would come to merely operate for awhile, there have to be opportunities for the future. The two must go together. SENATOR PEARCE surmised then that a transfer of ownership would be production. COMMISSIONER SHIVELY agreed. CHAIRMAN HALFORD interjected that it would include both ownership and operation. COMMISSIONER SHIVELY agreed and noted that there are a variety of ways to achieve such. According to how it has been done on the Slope, there would have to be someone with controlling interest in production and production facilities in order to be an operator. CHAIRMAN HALFORD pointed out that the conditions and 500,000 acre limit that are in statute are part of the ownership and lease side of the negotiations. He assumed that those are part of the contractual obligations which are protected by the constitution against unilateral amendment. COMMISSIONER SHIVELY agreed. CHAIRMAN HALFORD surmised then that real changes in those areas would have to be done in the negotiating process versus something in the legislature's power to change by law. COMMISSIONER SHIVELY said that he believed that to be true. CHAIRMAN HALFORD expressed the importance of understanding that is an area that can't be fixed by statute. SENATOR TAYLOR noted that it can be fixed with regard to future uses. CHAIRMAN HALFORD agreed, but believed the notion that we have absolute control over the 500,000 acre limit is a misnomer. SENATOR TAYLOR recalled that Commissioner Shively indicated that the return of those properties in excess of the 500,000 acre limit is a complex issue. Are there issues within that limit for which the legislature could provide some guidance to the Administration with regard to which property should be returned? Are there some vague areas within that law which are problematic? Number 275 COMMISSIONER SHIVELY replied no. He believed it clear that the companies have been given a property right. Those leases contain certain conditions, including the amount of acreage a company can own in non-unitized areas. As a result of the property right, the company has the ability to take actions with the lease themselves in order to come down to the 500,000 acre limit. If the company takes no action, the state has the right to make the company return the acreage to the state. Commissioner Shively didn't believe there to be much confusion on that point. CHAIRMAN HALFORD posed an example of a company which owns 51 percent of 100 acres. Although that company would have absolute control, it would count as 51 acres. REPRESENTATIVE KEMPLEN asked if the state would accept Exxon as a second operator. COMMISSIONER SHIVELY commented that there are an endless number of operators. Exxon Mobil will be the world's largest oil company and he believed having it as an operator on the Slope would be advantageous to the state. SENATOR ELTON recalled that Commissioner Shively had mentioned that some of the issues are complex and complicated. He expressed concern with the Governor's aggressive schedule to reach an agreement with BP. He wondered if the suggestion to file the anti- trust legislation would afford more time for negotiations with BP through the settlement process. COMMISSIONER SHIVELY pointed out that the schedule is somewhat driven by the schedule of the FTC. As previous testimony indicates, we must work in conjunction with the FTC because it has more clout than the state. At this point, he guessed the FTC could deal with this in November. As the attorney general and the Governor have said, if an agreement can't be reached, a suit will be filed. Commissioner Shively stressed his belief that filing suit is the last approach, not the first because once in court the number of issues becomes confined. The litigation would be confined to anti-trust issues. Therefore, in order to maximize what is on the table, there should be negotiations. SENATOR TAYLOR inquired as to the fate of the proposed $40 million gift to the university as a condition of the merger. COMMISSIONER SHIVELY wasn't sure. However, he reiterated that such an issue, BP's commitment to the community, would not be available if the state moved to litigation. SENATOR TAYLOR reminded the commissioner that the legislature appropriates money, not the Governor. If revenue is to be generated, it comes into the general fund. He stressed that the legislature should determine where such money is appropriated. COMMISSIONER SHIVELY said that he would relay that to the Governor. He commented that there is no question that if the money comes directly to the state, the legislature has the ability to appropriate it. If BP chooses to give money to the Boy Scouts or the university, that is BP's business and the legislature isn't generally involved. SENATOR TAYLOR stated: If, in fact, the negotiations on behalf of the people of the State of Alaska for a state-owned resource and revenue is generated from that or side deals made on where revenues are going to go should come through this legislature. (Indisc.) place an appropriation on whatever the needs are, I think the legislature deems to be most appropriate. CHAIRMAN HALFORD commented that he didn't disagree with Senator Taylor's premise, however he wouldn't pre-judge how the Administration would handle it. SENATOR TAYLOR said he wouldn't either. He clarified that he was suggesting there is an appropriate way to deal with such a condition which must be kept in mind. Number 351 SENATOR PEARCE asked if Commissioner Shively could inform the committee at what level the negotiations are occurring within the BP ARCO corporation. Does any negotiated agreement have to be placed before the company's board or can Mr. Browne merely make the decision? Is there any knowledge as to how long the process will take? COMMISSIONER SHIVELY stated, to his knowledge, the Chief Executive Officer has the ability to negotiate these issues. He believed that the shareholders of both companies have voted on the merger itself. Commissioner Shively believed, to his knowledge, that it wouldn't have to go before the board. However, that question hasn't been specifically answered. In terms of timing, BP isn't interested in prolonging the process. SENATOR PEARCE pointed out that the shareholders voted on a specific merger which included some specific statements regarding the financial gains. She expressed curiosity at what point the Federal Communications Commission (FCC) will make the companies take another vote of their shareholders, if the merger is different than what was originally voted on. COMMISSIONER SHIVELY said that he didn't have an opinion on that. CHAIRMAN HALFORD commented that that information should provide the state with some understanding of the state's relative benefits from this process. SENATOR TAYLOR asked if there is a price differential on a barrel of oil, if that barrel's ownership transfers, based on wellhead cost and field cost, from ARCO to BP. COMMISSIONER SHIVELY replied yes. SENATOR TAYLOR inquired as to the estimated loss or gain in state revenue. How much would be gained or lost if an ARCO barrel, worth X amount of dollars to the state, now becomes a BP barrel. COMMISSIONER SHIVELY stated that he couldn't answer that specifically. He noted that it wouldn't even be the same from month to month due to a variety of factors which affect both companies with regard to how their oil is priced. The price changes can largely be attributed to the transportation deductions. SENATOR TAYLOR said that he had heard that the mere transfer of ownership of a barrel of oil between the two companies would result in a significant loss of revenue to the state. He explained his understanding that the loss would occur because BP has higher field costs or associated production costs. COMMISSIONER SHIVELY indicated that is basically the transportation costs. Some of that does work itself out due to the efficiencies that occur as BP is able to align its shipping interest with where production comes from. SENATOR TAYLOR commented that although some of it may work out because of efficiencies, overall there would be a loss in that volume of production. COMMISSIONER SHIVELY responded that there may or may not be a loss. He said that he couldn't answer that question now. He reiterated that the settlement agreements all provide for reopeners on a regular basis. Therefore, there are ways outside of the merger to deal with such an issue. CHAIRMAN HALFORD stated: We, ..., picked the month with the highest differential and tried to run it through and there were explanations back from the Administration when we did that. But if we ran through the month that we picked and the explanations didn't come through, the ... range of that difference of converting all ARCO barrels to all BP barrels - in that worst month scenario were then annualized - was in the range of $80 million a year. It was significant, but the answers back pointed out that some of that wouldn't happen and some, on the other side, might come up. It's at least a question that is very worthwhile to ask and to try and figure out. COMMISSIONER SHIVELY agreed that it is also worth keeping track of, but he reiterated that he wasn't sure that everything can be fixed within this merger. CHAIRMAN HALFORD interjected that it seems that part of that is bound by settlements which go with the oil, not with the owner. SENATOR PEARCE asked if the knowledge of whether there is a reopener on those is confidential information. COMMISSIONER SHIVELY answered that he didn't know the answer to that, but offered to find that answer. REPRESENTATIVE KEMPLEN asked if Commissioner Shively makes a distinction between an owner and an operator. If so, please clarify the two. Number 425 COMMISSIONER SHIVELY said that he does make a distinction between an owner and an operator. He pointed out that lots of people own leases and the oil under them in Prudhoe Bay. However, two or three actually manage a field or fields. He explained that an operator is one who performs the management, hiring personnel and contractors who work in the field. The operators produce the cost estimates for capital constructions. The operator receives a fee for managing. Therefore, there are a number of owners with, traditionally, only two operators in terms of production. Commissioner Shively noted that Exxon is designated the operator of Point Thompson, but since Exxon hasn't really produced anything he didn't consider them an operator. CHAIRMAN HALFORD pointed out that the series of maps, the pre- merger and post merger map, illustrate the operators for given fields. He clarified that the leases indicate owners. REPRESENTATIVE KEMPLEN asked if there could be a situation in which BP could be a part owner, although a very influential owner, with two operators. COMMISSIONER SHIVELY agreed that could be correct theoretically. However, he didn't believe that any oil company would want to operate in a field in which it didn't have controlling interest. Such has not been the case in the past. REPRESENTATIVE KEMPLEN surmised then that a second operator would really mean another owner. COMMISSIONER SHIVELY clarified that it may not be another owner. Perhaps, someone who already owns a piece of the field takes a bigger piece by purchasing it from BP. It would be a different company that would be the operator and they would have a different percentage ownership than currently. REPRESENTATIVE KEMPLEN understood then that the predominant color, green, on the map would change after the settlement. COMMISSIONER SHIVELY agreed and noted that to be the point of the divestiture. SENATOR ELTON asked if Commissioner Shively envisioned the pipeline tariff as one of the fixes that would occur outside the merger context. COMMISSIONER SHIVELY answered that the issue of pipeline tariffs is on the table. He reiterated that the issue of pipeline tariffs is a complex issue due to an agreement which the state was involved in. The current tariff situation is clearly anti-competitive. There are a variety of solutions. Therefore, in terms of a new operator that is an issue that must be addressed. SENATOR TAYLOR inquired as to whether there has been contemplation of any changes in existing legislation or a new package of legislation in order to encourage independent operators to enter Alaska. If so, what has been contemplated? COMMISSIONER SHIVELY replied no. If there is a competitive system combined with the area wide leasing program, that would allow entrants. He believed that without reviewing divestiture there wouldn't have been much interest from others on the North Slope. Once the divestiture situation unfolds, he believed it will add to the interest of other independent oil companies to come to Alaska. At this point, there is no anticipation of any legislation which would change the current bidding system. He commented that the bidding system had worked well until ARCO decided it didn't want to be there any longer. CHAIRMAN HALFORD predicted then that the state would be able to measure its success in the number of bidders in the next major North Slope lease sale. COMMISSIONER SHIVELY affirmed that could be the case. He pointed out that the Beaufort sale had just been postponed because he felt the current instability didn't maximize the state's opportunity for others to enter. CHAIRMAN HALFORD commented that he believed that to be a good decision. SENATOR TAYLOR said that he didn't believe there was a choice with regard to divestiture, that law had to be enforced. He acknowledged that divestiture may be a negotiating point. Senator Taylor asked if the assumption would be that upon resolution of the divestiture, there would be additional and more attractive properties to offer. COMMISSIONER SHIVELY responded that is unclear because there is no knowledge as to whether properties will be returned to the state or whether BP will make changes. He referred to maps present at the hearing. He noted that one of the challenges the state faces is that the state owns from [Mount] Canning to [Mount] Colville and most of the good acreage is currently leased. There have been some interest in various geological formations to the south. Anadarko has made a commitment to review Arctic Slope lands well south of the state's lands. COMMISSIONER SHIVELY turned to the North Slope and the potential for new fields. He indicated that one would look at what would occur in the National Petroleum Reserve-Alaska (NPR-A) which is mentioned with regard to divestiture. Regardless of changing or keeping the current law, he didn't believe many would be excited by the acreage. He pointed out that currently some relatively small companies are bidding large amounts for strategic leases which they believe will connect with existing fields. However, there is not much great acreage at this point. SENATOR TAYLOR surmised then that divestiture would be left up to the companies to decide what negotiations they may have with their partial owners. After they make the decision with regard to what they return to the state, the state will... COMMISSIONER SHIVELY interjected that would not be the exact scenario. He said that he wouldn't discuss the total negotiating strategy. However, he believed that the state has a role in how the divestiture will end up. The divestiture is not being totally left in BP's hands. CHAIRMAN HALFORD reiterated that the law is clear and not in the state's favor. This is an issue that must be won in negotiations. COMMISSIONER SHIVELY agreed. However, the divestiture model for the FTC and the state will have to meet certain criteria, regardless, which will be BP's problem. He specified that was his personal thought. Number 536 REPRESENTATIVE CISSNA recalled that there was a question regarding the DR&R (Dismantling, Removal and Restoration) funds in escrow and the state demanding discontinuation of that collection. COMMISSIONER SHIVELY informed everyone that Mr. Fineberg has requested that he have nothing further to do with that issue. Mr. Fineberg believes Commissioner Shively has a conflict of interest because how the state deals with DR&R was part of the tariff settlement developed when Commissioner Shively was Chief of Staff. At this point, Commissioner Shively said that he hasn't made a decision on that point yet. Commissioner Shively stressed that DR&R has never been made an issue and has never been handled that way in any location. He assumed that when it comes time to cleanup, a big company would do so. He turned to the Cook Inlet when Shell decided to sell to Cross Timbers. When Shell wanted to transfer the leases, the state informed Shell it could transfer the leases, but it couldn't transfer its responsibility if Cross Timbers can't clean it up. Therefore, a different scenario was utilized for DR&R for Cross Timbers because Cross Timbers is smaller. At this point, the state doesn't require large companies to escrow DR&R. CHAIRMAN HALFORD commented that he too was around when the tariff settlement was developed. Bob Maynard did much of that negotiation. Both Mr. Maynard and the Administration at that time did the best that they could. If they made mistakes, those are mistakes that can be identified in hindsight with much new information. Chairman Halford explained that most of the money returns to them because it was their oil. It was a portion of the tariff on all the oil that went through. Therefore, the numbers look bigger than he thought they would come out. Chairman Halford indicated that it is an exercise that may not arrive where he had initially hoped. REPRESENTATIVE KERTTULA spoke to the comments regarding the loss of some conditions if the state were to go to court. However, if the state filed an anti-trust lawsuit and the merger stopped, then a different scenario would exist. COMMISSIONER SHIVELY acknowledged that BP may find that there are requirements that make the deal unattractive. Whether BP would return to its shareholders or make a decision to oppose the deal, that would be BP's decision. Commissioner Shively believed that ARCO has made a decision. If BP changes its mind, he didn't expect ARCO to remain in the long-run. CHAIRMAN HALFORD asked if it was possible that ARCO's situation changed between the time of $13 and $24 oil. COMMISSIONER SHIVELY believed, personally, that the decision was broader than the price of oil at the time. Although ARCO is in better shape today, he believed review of ARCO's Alaska operations reveal that it was a viable company and could continue as such. However, ARCO had other operations. TAPE 99-6, SIDE B SENATOR PEARCE asked if Usibelli, for example, has to escrow money as they cleanup or do they also have to escrow money for final remediation. COMMISSIONER SHIVELY answered that, to his knowledge, Usibelli wouldn't escrow any money. However, there are some things which require bonds and there is also a state bonding pool to which mining companies contribute. Number 578 FRED BONESS, Attorney, Preston, Gates & Ellis, testified as outside counsel for the committee. He informed the committee that a number of the topics he had intended to address had been addressed by Commissioner Shively. Mr. Boness turned to the issue of the divestiture or interests and leases on the North Slope. Previous discussions have used the word divestiture in various different contexts. He noted that he would first discuss divestiture in terms of the state statute, which requires divestiture of state leases. He highlighted the limited nature of the divestiture statute. He referred to the map as well. The state statute requires when there is over 500,000 acres divestiture must occur, in non-unitized areas. He explained non-unitized as being essentially not developed. Therefore, the discussion is not about Prudhoe Bay, Kuparuk, Badami, or Duck Island all of which are unitized. He commented that BP would probably attempt to get below the 500,000 acre maximum in order to bid in the future. Mr. Boness explained, "When they do that, if they own 100 acres -- 100 percent of the lease, for simplicity, 100 acres. If they divest 49 percent of that, then under the statute they own 51 percent of the lease and it's credited as 51 acres." Therefore, in many of the areas where BP owns a lease now or after the merger, that could remain green [controlled by BP] simply by reducing the percentage of ownership in those leases. CHAIRMAN HALFORD asked if the change, between the maps, could occur under the 500,000 acre limit. MR. BONESS replied yes, but noted that he hasn't worked out the math. He mentioned that it may be easier to achieve the same objective by eliminating a lease here and there. He pointed out another important aspect. For instance, if BP recognizes that there is a logical unit in the future, then BP could choose to divest, in total, the leases outside of that unit in order to continue to own some percentage within the unit expected in the future. If BP determines that it has some leases that aren't particularly valuable or unlikely to be in the overall plan, BP could choose to divest those leases. That would still accomplish the objectives, and therefore it wouldn't matter that some of the lease tracks weren't green [controlled by BP]. Perhaps, it will be far more important which areas remain green [controlled by BP] and the percentage at which they remain so. MR. BONESS clarified that the divestiture to which Commissioner Shively referred is a negotiated divestiture, which is probably premised on the anti-trust notion of divestiture. For example, in the CARRS Safeway merger there was a divestiture of certain CARRS stores. That divestiture was an anti-trust type of divestiture, not a concept which specifies the amount of grocery stores that one owner can own. Therefore, the notion of going beyond the lease is important. Mr. Boness pointed out that the only divestiture required by the state statute is that which is not in units. However, Commissioner Shively indicated that there is the desire for divestiture of production as well, which would have to be premised on an anti-trust concept. MR. BONESS mentioned that he had intended to address the distinction between an owner and an operator, but Commissioner Shively has already covered that issue. However, he said: I think some of the questions and Commissioner Shively's answers were in the context of what if BP continues to have a controlling interest. And I suppose for most purposes, people would think that that means 51 percent or more. You can go again to the concept of maybe there's a block out there where BP is going to divest 49 percent. And I think it's important to keep in mind that it may not be a controlling interest in the sense of 51 percent that is important to focus on in the negotiations with divestiture. Because, typically, when you get into, for example, negotiations by owners with respect to sharing of facilities, the requirement is going to be more than, in many of the agreements amongst the parties, ... 50 percent approval. In other words, ..., in the agreements that exist up there if I come to the various owners of a unit up there and say I would like to gain access to your facilities, it may not be that I have to have 100 percent approval of all the owners, although it is possible I would have to have 100 percent. But I, almost certainly, am going to have to have something like 66 percent of 75 percent or 90 percent. Therefore, if BP divests in such a way that they own a percentage which gives them veto power, as opposed to controlling power, that is something that has to be considered and kept in mind in analyzing the divestiture. I think where that leads one is simply underscores the notion that the negotiation and the ability to implement a program which will encourage competition is, as Commissioner Shively said, complicated because it does involve these kinds of considerations of control via the veto power as well as control by a more traditional way of having majority ownership in the matter. Number 496 MR. BONESS turned to the subject of net-back in revenues. He clarified that field costs don't really enter in to the state's revenue considerations of the merger. He acknowledged that there are various ways that the state receives revenue from the industry in the area of taxes. He explained that the production tax, commonly referred to as the severance tax, taxes a percentage of the value at the point of production. In the case of Prudhoe Bay, the point of production is pump station one. Therefore, the severance tax values the oil from pump station. He pointed out that the cost of getting the oil from the wellhead to pump station one is irrelevant for purposes of the state's valuation because that valuation is done on a net-back. He explained that the net- back starts with a price in California or Asia and the cost of the transportation and the pipeline tariff are subtracted out. For severance tax purposes, no field costs are subtracted out. MR. BONESS turned to royalties. Field costs do enter into royalties. He explained that royalties are what landowners typically reserve for themselves when entering into an oil and gas lease. This is a common practice, which Alaska followed when it leased lands on the North Slope. The original leases specified that royalty is valued at the wellhead. He informed the committee that the wellhead was part of litigation filed in the 1970s. He believed that the wellhead portion of the litigation was settled in 1980. The settlement provided that the field cost deduction be a fixed amount with some adjustment provisions. Therefore, the deduction for field costs with respect to royalties is a fixed number which isn't really tied to costs. CHAIRMAN HALFORD understood then that the effect would be as follows. If there is a $1 billion savings which is in the field before the oil gets to pump station one, the state shares nothing in the benefit of that savings. MR. BONESS responded, that is correct. He emphasized the importance of that realization. BP has advanced the justification that there will be a substantial savings in lifting costs. Such a rationalization is good, from a purely economic standpoint. However, BP may not have to acquire ARCO for such to occur. He stressed that those savings will not be reflected in the current royalty structure. Furthermore, the legislature doesn't really have any access to do anything about those savings. He pointed out that those savings wouldn't be reflected in production taxes either because the legislature made the valuation at pump station one. The legislature is limited with regard to capturing a share of those benefits. Mr. Boness stated that the state can capture benefits in reductions of the tariff or tanker charges which are a function of the net-back. He believed the estimate to be if the tariff decreases by one cent, the net benefit to the state is approximately $910,000. Therefore, there is a substantial benefit to the state in having reductions in the tariff. Mr. Boness agreed with Commissioner Shively in regards to a strictly anti-trust forum, such a lawsuit would not allow a great ability for adjustments in the tariff. He informed the committee that BP has always filed at the maximum tariff. That tariff is governed by settlement agreements entered into in 1985 with some adjustments. He explained that those adjustments were the result of litigation with regard to the complexities of the federal regulatory system in place at that time. Mr. Boness believed that dealing with the tariff can only be achieved through the negotiation process. MR. BONESS, per Representative Kerttula's request, addressed the TAPS settlement methodology (TSM). The TSM agreement provides that between 2006 and 2008, the parties will attempt to negotiate a new agreement. If the parties haven't entered into a new agreement by 2008, the TSM terminates. Therefore, the state and the companies would return to setting tariffs under the federal law which didn't work very well and resulted in the TSM. This should be kept in mind as it is very important to the state's overall financial picture. MR. BONESS pointed out that many are concerned with the technology and innovation impacts that result from the elimination of any entity such as ARCO. For example, advances in technology have increased the projected 10 billion barrels of oil from Prudhoe Bay. He believed that Prudhoe Bay has already produced 12 billion barrels of oil and continues to produce substantial oil. That increase in production can be substantially attributed to advances in technology such as lateral drilling. He recognized the concern that two thinkers/organizations with two sets of ideas is almost always better than centralized control. Number 383 REPRESENTATIVE DAVIES asked if the Administration could negotiate a voluntary reduction in the tariff in order to reduce the tariff. If so, how would that affect the other capacity (indisc.)? MR. BONESS agreed that the Administration could try to negotiate a voluntary reduction in the tariff. There are various options the Administration could take in this area. He pointed out that, to some extent, ARCO's tariff has always been lower than BP's tariff. He noted that it is a function of tanker charges. Therefore, one negotiating posture would be to simply ensure that formerly-owned ARCO barrels are treated under the same tariff as if under ARCO. Such a posture wouldn't necessarily require an amendment to the TSM. Mr. Boness expressed concern that there are ways to negotiate for competition, but what is being discussed is competition among a small entity. REPRESENTATIVE KERTTULA understood the question to have a mix with regard to tariff reduction and increase in capacity. She didn't believe that capacity would be increased. MR. BONESS clarified that capacity and competition are intertwined here. One group identifies capacity as whatever goes down the pipeline. Another group identifies capacity as whatever could go down the pipeline. Those two aren't necessarily the same. Obviously, as pump stations are taken off line, capacity decreases. However, if there is less oil put down the pipeline and the pump station is not paid off, there could be additional capacity. Mr. Boness informed the committee of the drag resistant agent (DRA). He explained that by placing more or less of the DRA into the pipeline, the capacity can be increased or decreased. Therefore, there isn't a fixed number with regard to the amount of oil that can travel down the pipeline. He believed that the state and other parties negotiated a capacity settlement agreement in 1997. That capacity settlement agreement defined a set of parameters such that there will always be the assumption for tariff purposes that there is a capacity of 105 percent. Consequently, there is more pipeline capacity than there are barrels to go down the pipeline. That was intended to create competition. He stated that the merger will not better the situation. MR. BONESS informed the committee that BP also claims there will be a better alignment of ownership of oil and gas. He believed that was fair to say, however there are trade offs. In Prudhoe Bay there has been differences in ownership of gas and oil which have often resulted in production compromises. He mentioned that BP would refer to them as costs and inefficiencies. If BP acquires ARCO, the better alignment would result in more effective and efficient decision-making. He acknowledged that is probably true. "The question to the extent that ... it results in cost savings, ... independent of royalty benefits, independent of severance tax benefits and the state's benefit will be limited to that which may result in additional production, if in fact some marginal barrels of oil are produced sooner than they otherwise would have been." He noted that assessing that is very difficult due to the interplay between technological developments. Furthermore, the trade off impacts the question of natural gas commercialization. He believed there is a question with regard to how that could be factored in the overall negotiations. Again, the matter won't be easily addressed in a strictly anti-trust litigation. Therefore, he felt it important to discuss the tax structure and how it relates to the various benefits which Mr. Messenger will address. SENATOR TAYLOR said that those people who own those interests within those leases have done studies on their properties and know what is present. Does the state have that information? MR. BONESS answered that the state does have some of that information. Furthermore, the leaseholders don't have the same level of information amongst themselves. SENATOR TAYLOR expressed concern with this situation because it reminds him of the game Battleship in that the leaseholders have information which the state doesn't. He indicated that the negotiations occur without the same knowledge and thus could result in one player having the choice properties. How does one avoid such a situation? Number 276 MR. BONESS said that he believed there is an element of correctness to Senator Taylor's comments. However, any one negotiator has his/her own level of information. The state has information from other parties, which may not be available to BP. Mr. Boness believed that the state has the following choices: if the state is satisfied with the information, the state can make judgements based on that information; the state could simply demand BP to provide the state with the information it is utilizing to negotiate its position. He believed that BP has said that it intends to make seismic information available to the potential purchasers. Mr. Boness agreed that there may be different levels of information, but didn't believe it is at the same level as Battleship. SENATOR TAYLOR disagreed with the comments, of both Mr. Boness and Commissioner Shively, that merely filing an anti-trust action would not allow the state to do these things. The resolution of an anti- trust action could involve many other parameters. MR. BONESS commented that anti-trust lawsuits are huge and expensive endeavors. Once the lawsuit is filed, the dynamics of negotiations are likely to change. That is a judgement call that has to be made by those doing the negotiating. As an attorney, Mr. Boness has experienced that things change, in comparison to the time before the lawsuit was filed, for an extended period of time once a lawsuit is filed. He didn't disagree with Senator Taylor's comments with regard to what is on the table for settlement purposes, once a lawsuit is filed. Mr. Boness stated that the decision to accept a particular settlement without filing a lawsuit or filing a lawsuit and negotiating back to what could've been achieved before the lawsuit is a judgement call. SENATOR TAYLOR understood there will be negotiations to reach a settlement which will be presented to the people of Alaska. All of this will occur prior to the final decision regarding whether a suit will be filed. He wasn't sure what would occur at that point. If the public is happy, is the process over. If the public is unhappy, will the state return to the drawing board. That is of concern. CHAIRMAN HALFORD stated that he shared Senator Taylor's concern. With regard to the access to seismic data, it has been a major issue for many years. REPRESENTATIVE KERTTULA pointed out that filing a lawsuit has its own intrinsic value, in terms of pressure. She agreed that filing a lawsuit wouldn't take issues off the table. However, she believed that filing an anti-trust suit without a settlement would limit some of the possible remedies in the long run. For instance, she didn't believe that the issue of Alaska hire would be settled in a court. She agreed that the settlement could address that issue. SENATOR TAYLOR agreed that the lawsuit may place some limitations upon where negotiations go and the final options. However, he was concerned with the speed with which this process is occurring, the lack of public input, and the need to sign confidentiality agreements for information. Senator Taylor emphasized that he would like to be informed as to how much BP and ARCO owe in back taxes. Should someone request those taxes be paid before the deal is resolved? He noted that one can't obtain such information without signing a confidentiality agreement. That should be public information. Senator Taylor also expressed the need to resolve the question of corporate taxation within the merger. Number 162 REPRESENTATIVE KEMPLEN returned to the issue of tariffs. He understood Mr. Boness to have said that for each dollar reduction in tariffs, the state would see a $90 million increase in revenues. Later, Representative Kemplen received the impression that the state is locked into those tariffs because of the TSM. Therefore, the question seemed to be whether the state would not lose any revenues. MR. BONESS explained that the state obtains more revenue by reducing costs from either the tankers or the tariffs, et cetera. The TSM establishes a maximum rate, and therefore the state can increase its revenue by lowering the rate. He explained that a TSM reduction would require a revision to the existing TSM or require that barrels of oil currently under a tariff established by ARCO will continue as such. REPRESENTATIVE KEMPLEN understood then that it is possible to negotiate that the state would want all the barrels of oil to be treated as under the ARCO arrangement. MR. BONESS replied that it would be possible, theoretically. CHAIRMAN HALFORD interjected that the actual agreements go with the barrels to the new purchaser. MR. BONESS clarified: There is a provision in the agreements that, what lawyers call covenants running with the land; but there is also a provision in a different agreement or a different part of the agreement that says ... when BP acquires ARCO, BP has the right to elect to treat the ARCO barrels as if they're BP barrels. Mr. Boness said that the state could lose money that the state could have received had the merger not occurred. [Manual tape change, approximately 5 minutes of blank tape.] TAPE 99-7, SIDE A Number 026 JOHN MESSENGER, Attorney, Preston, Gates & Ellis, informed everyone that he is a partner of Mr. Boness, counsel to the committee. He announced that he would be discussing the tax structure. The tax structure is important with regard to the impact the merger will have on Alaska's tax revenues. He indicated that he would also address whether the current tax structure is appropriate, given the new environment after the merger. He noted that the committee had been provided a series of charts, which illustrate some of the points he will be making. Mr. Messenger referred to the charts entitled, "Comparison of Actual Oil and Gas Corporate Income Tax Collected with Estimated Revenues using a Separate Accounting Income Tax Approach Assuming Existing AS 43.20 Rate" and "Net Income From Prudhoe Bay and TAPS." These charts should help address questions involving the corporate income tax as they illustrate the difference in separate accounting and formula apportionment. He explained that the tall bars on these two charts represent the profits that would be earned by the industry in Alaska directly, without reference to operations that occur worldwide. The lower bars represent the tax base under formula apportionment, which is another type of corporate income tax. MR. MESSENGER addressed the situation that the state faced in 1978, which relates to the tall blue bars on the "Net Income From Prudhoe Bay and TAPS" chart. The blue bars refer to the net income or profit from Prudhoe Bay and TAPS as estimated by various parties. The short red bars on this graph illustrate the amount to be measured under formula apportionment. At that time, the legislature made the judgement that the industry wasn't paying an effective tax rate similar to what a corporation would earn if it was operating those same assets in the state. In other words, the oil companies were paying a tax rate substantially below the 9.4 tax rate that other corporations were paying. The debate was regarding how to change the corporate income tax such that the oil companies would pay a fair portion of the corporate income tax as being paid by other corporations. Ultimately, the legislature adopted the separate accounting approach, which more accurately measured that income earned directly in Alaska. Therefore, the issue became whether the oil industry was willing to pay 9.4 percent of the income it was actually earning in Alaska. Mr. Messenger read the following question, which illustrates the nub of the dispute, posed by Senator Huber at a committee hearing. Senator Huber asked Mr. Donaldson, an executive of SOHIO, the following: Does SOHIO object to paying 9.4 percent on its true net income, the same as they would have to pay if they were strictly an Alaskan corporation. Mr. Messenger said that Mr. Donaldson replied, "Yes." Number 160 MR. MESSENGER explained that separate accounting merely measures the activities in the state and measures that directly which, in the case of the oil companies, would be the production, pipeline and transportation operations, et cetera. Formula apportionment, on the other hand, would review the company's worldwide income and then apply a formula. That formula, property, payroll, and sales, would then be multiplied times that worldwide income in order to estimate the amount of activity taking place in the state. He said that the formula didn't correctly reflect the amount of activity in the state because those factors didn't account for the sale of oil that took place outside of the state or the value of the oil and gas reserves as property. Therefore, the legislature passed the separate accounting bill in order to focus Alaska's tax structure on activities that were taking place in Alaska. The oil companies challenged the separate accounting statute and ultimately, the Alaska Supreme Court approved the constitutionality of the tax in 1985. Subsequently, in 1986 the oil companies took that to the U.S. Supreme Court, who dismissed the appeal by the oil companies for want of a substantial federal question. In 1981, the uncertainty with regard to the lawsuit and the amount of liability, led the legislature to repeal the separate accounting bill and substitute another form of apportionment. Therefore, the repeal wasn't based on a change in policy. MR. MESSENGER turned to the chart entitled, "Comparison of Actual Oil and Gas Corporate Income Tax Collected with Estimated Revenues using a Separate Accounting Income Tax Approach Assuming Existing AS 43.20 Rate." In this chart the tall red bars represent the estimated separate accounting revenues, while the small blue bars represent the actual O&G income tax collected. When the legislature passed the new tax laws in 1981, the legislature modified the apportionment formula so that it better reflected activity in Alaska. The modified apportionment formula substituted an extraction factor for the payroll factor, which took into account actual production in Alaska versus production elsewhere. Still, that formula didn't result in earnings parallel to earnings measured more directly under the separate accounting approach. CHAIRMAN HALFORD observed that the charts seem to reveal that the higher the oil price, the higher and more significant the loss from having apportionment versus separate accounting. MR. MESSENGER agreed that Chairman Halford's observation is the case. It is a trade off between profitability in Alaska versus profitability elsewhere. He recognized that oil prices affect the company worldwide. In terms of prices in Alaska, the higher bars seem to occur during higher oil prices in Alaska. Mr. Messenger clarified that this chart, "Comparison of Actual Oil and Gas Corporate Income Tax Collected with Estimated Revenues using a Separate Accounting Income Tax Approach Assuming Existing AS 43.20 Rate," represents information from 1982-1997. He recalled that a letter from the Commissioner of Revenue indicated that, for the next five years, formula apportionment would collect approximately $150 million per year. If the separate accounting approach were in effect, that collection would be 50 percent higher. That is, another $75 million per year would be collected under a separate accounting approach. CHAIRMAN HALFORD pointed out that the Commissioner of Revenue's statement was made when oil prices and projections were in the $13 range versus the $23 range. MR. MESSENGER indicated that he wasn't sure of the date of the Commissioner of Revenue's comments. If Chairman Halford is correct, then higher prices would result in higher collections. MR. MESSENGER returned to the chart entitled, "Comparison of Actual Oil and Gas Corporate Income Tax Collected with Estimated Revenues using a Separate Accounting Income Tax Approach Assuming Existing AS 43.20 Rate." He explained that 1982 is a transition year, the year when the separate accounting approach changed to the modified apportionment. Therefore, 1982 includes some overlap in earnings from both approaches. Mr. Messenger stated that this chart reflects the difference between the two methodologies. However, he clarified that the chart doesn't mean that the state lost this entire amount when the law was changed in 1981. That would be a separate calculation. Number 281 REPRESENTATIVE GREEN asked if this chart follows, although not dollar for dollar, crude prices. He asked: If we're using a modified apportion on the worldwide profits, - where you're dealing with vertically integrated companies that actually make money on crude purchase or sale and refining and marketing - wouldn't that have much less of an exaggeration compared, and I think that's what this shows, in the crude price since essentially all we get from those is the crude price (indisc.). MR. MESSENGER clarified that it is not just the crude oil price, it is activity in Alaska. The state's fortunes are being tied to the company's profits and activities in Alaska which would include their earnings on oil produced in Alaska as well as the company's earnings from their pipeline assets in Alaska. Mr. Messenger agreed with Representative Green, in that formula apportionment will be affected by a variety of things which happen to the company worldwide. On the other hand, separate accounting focuses on activities in Alaska. Therefore, the question is what is better for Alaska in the long-term. CHAIRMAN HALFORD commented that previous discussions have included comments regarding at what point, on the downside, does apportionment reflect a better picture for the state. He recalled that number to be considerably lower than the lowest number "we" have seen. The danger sign would be if the pipeline was shut down for a two month period, then there would be real problems. However, he inquired as to whether the state wants to bet on its own actions or some else's actions. He stated, "Of all the exposures that were argued in the past, we've never gotten near a price that wouldn't generate more under separate accounting than it generates under apportionment." SENATOR ELTON interpreted the discussion to say that before separate accounting, oil companies were paying less at approximately 3.5 percent in corporate taxes. He asked if under separate accounting, the oil companies paid a corporate income tax more or less equal to that paid by Alaskan corporations and now, the oil companies have fallen below Alaskan corporations. MR. MESSENGER, in a general sense, agreed with Senator Elton. He reiterated that the separate accounting approach measures an amount of income that would be commensurate with an Alaskan company as opposed to an approach where the income is estimated by a formula based upon occurrences elsewhere. Number 337 REPRESENTATIVE GREEN posed a situation in which another operator entered. If that operator was strictly an Alaskan company, would this type of differential unfairly penalize such an operator. MR. MESSENGER specified that it would depend upon the company. Obviously, an apportionment formula would result in paying less tax, which is advantageous to the company. However, this is an income tax, which many believe to be the fairest type of tax. He then turned to the barrel chart entitled, "Estimated Revenues and Costs per Barrel of Alaskan Crude Oil." This chart illustrates how the separate accounting approach taxes. He noted that one of the arguments made by the oil companies in the lawsuit against Alaska was that the separate accounting approach was unfair. The oil companies believed it to be unfair because Alaska was taxing 100 percent of the barrel of oil, and therefore reached income/activity outside of Alaska. He noted that this chart was actually included in the Alaska Supreme Court opinion upholding the constitutionality of Alaska's tax. The chart illustrates that the separate accounting approach only taxes halfway down the equation, which is the wellhead. He clarified that the gross income under a separate accounting approach for production income is the value at the wellhead. From that, the companies are allowed to deduct royalty, production taxes, ad valorem taxes, direct operating costs, acquisition and development costs, uncapitalized interest, overhead, and exploration costs. Therefore, only the profit would be subject to tax. Also the state wouldn't tax anything downstream of that such as refining, marketing, et cetera. In terms of the merger, the separate accounting approach would allow both BP and the state to share in the savings. He explained that as a company would become more efficient and reduce costs, that company's reductions on their tax return would be reduced. However, it would increase the company's profits and the net income subject to tax. Under the worldwide apportionment approach, those cost reductions become more diffused in the overall operation and the state would receive a slice of that in the formula apportionment approach. CHAIRMAN HALFORD related his, admittedly naive, assumption, "If they saved a billion dollars and our structure gained a third of that, somewhere along the way, without changing the laws ..., the State of Alaska would receive $330 million." Now he has heard that will not happen in both royalty and severance taxes. Furthermore, he pointed out that apportionment occurs at a rate of about six percent while the rate under separate accounting would be 9.4 percent. Therefore, the amount the state would receive from that billion dollars would only be $60 million under apportionment and $94 million under separate accounting. MR. MESSENGER stated that it is really worse than Chairman Halford's scenario because the state isn't receiving that six percent of the cost savings. He explained that the companies overall costs are included in its worldwide operation, and therefore only a minuscule portion of the slice of that cost would be received by the state. REPRESENTATIVE GREEN referred to the chart entitled, "Net Income from Prudhoe Bay and TAPS." He pointed out that the net income from Prudhoe Bay and TAPS, the blue bars, are practically equal for Exxon and ARCO. While the red bars, the UDITPA tax base, illustrate a significant difference between Exxon and ARCO. He indicated that difference would support the discussion that ARCO's worldwide misfortunes drew ARCO down, not its operations in Alaska. Therefore, Representative Green believed that to provide further support for revisiting the separate accounting approach. Representative Green, in response to Chairman Halford, said that he realized that chart is from 1979. Number 425 SENATOR ELTON referred to the "Estimated Revenues and Costs per Barrel of Alaskan Crude Oil" chart and inquired as to why tanker costs and profits are exempted. MR. MESSENGER noted that there are some constitutional questions which relate to how far the state can reach with its tax powers. He reiterated that the state was only looking to activities taking place inside of Alaska. Some tankers spend some time in Alaska, but their major operations are outside of the state. Therefore, the category of taxation referred to as other income was established in order to accommodate situations in which there was some activity in Alaska by the oil industry which didn't fall under production or pipeline transportation. That other income was multiplied times the formula while subtracting out pipeline income, production income, and the activities in the formula related to those. So, anything left would represent any other activity. MR. MESSENGER turned to the severance tax and directed the committee to the three charts entitled, "Economic Limit Factor." He explained that the current ELF applies two nominal tax rates to the value of the oil at the point of production. As Mr. Boness mentioned, the value of the tax is determined at pump station one, in the case of the North Slope. There is also a cents per barrel tax rate, 80 cents per barrel, which the state would receive even if the value of the oil fell below a certain level. He estimated the threshold to be about $5.33. If the value of oil fell below $5.33, the tax rate would be $.80 per barrel multiplied by the ELF rather than a percentage of value. Any value above $5.33 and the value rate applies. CHAIRMAN HALFORD surmised then that $.80 per barrel multiplied by .1 equals $.08 per barrel. MR. MESSENGER continued by saying, "Nominally, under the statute, it's 15 percent of value or in the case of new properties, it's 12.25 percent for five years and then it goes to 15. That then is multiplied times the ... ELF which then gives you your ... effective tax rate." He further explained that when the ELF is close to one, that is tantamount to multiplying the tax rate by one, which results in the same tax rate. If the ELF is below one, then the nominal tax rate is reduced. For example, Prudhoe Bay oil has a nominal tax rate of 15 percent and an ELF of 95 percent which results in an effective tax rate of 12.47 percent. He referred to the double-sided chart entitled, "Economic Limit Factor" which illustrates that newer fields, those five years from commercial production, have a nominal tax rate of 12.25 percent. Those have a lower effective tax rate. MR. MESSENGER commented that the ELF is a complicated figure that is computed under the formula by factors of production, days, the number of wells, and field size. Fields larger than 150 barrels per day have a higher ELF than those smaller fields. Therefore, there is an incentive to be a new small field because the effective tax rate will be lower. Number 501 REPRESENTATIVE GREEN inquired as to why the nominal tax rate multiplied by the ELF does not equal the effective tax rate. MR. MESSENGER said that this information was provided to him. CHAIRMAN HALFORD pointed out that from 1999 to 2003, there is an overall decrease from 11 to under nine which is a 20 percent reduction in severance tax average for all Alaska production in the next four years. MR. MESSENGER replied that he didn't have an answer for this right now. However, he mentioned that 1981 was the year the separate accounting bill was repealed. To make up for that repeal the state enacted the modified apportionment income tax. As illustrated the modified apportionment income tax doesn't measure up to the separate accounting approach. Therefore, the severance tax rate was raised from 12.25 percent to 15 percent. The state also set the ELF at one for Prudhoe Bay for a 10 year period beginning with the commencement of production. He believed that the ELF of one for Prudhoe Bay ended in 1987. Subsequent to that, the legislature changed the ELF by introducing the field size component to the ELF. Therefore, raising the ELF for larger fields and reducing the ELF for smaller fields. This is the situation today. CHAIRMAN HALFORD commented that, in that time frame, it was a net benefit due to the size of Prudhoe Bay and Kuparuk. In this time frame, the ELF was reduced for the smaller fields. He identified the current difficulty as Prudhoe Bay production is being replaced with small field production. MR. MESSENGER noted, as the chart illustrates, that the ELF is continuing to decrease which affects the severance tax revenues over time. REPRESENTATIVE DAVIES surmised: If we were to have another owner/operator on the North Slope and they were to want to have access to existing facilities - which are at some limit right now - and you substituted a new barrel with existing barrels from Prudhoe Bay, we would lose because of the economic limit factor. CHAIRMAN HALFORD clarified that a one percent severance tax barrel would be substituted for a 12 percent severance tax barrel. MR. MESSENGER interjected that the incentive is to get production under something classified as new and small. SENATOR PEARCE asked if the state has ever challenged whether production coming on-line be called a new field versus a satellite. MR. MESSENGER said that nothing comes to mind. SENATOR PEARCE asked if advertising and public relations expenses are deductible in the corporate income tax for the oil companies. MR. MESSENGER answered that he didn't know the answer to that question, although he assumed such expenses are deductible. REPRESENTATIVE KERTTULA informed the committee that Charlie Cole, the ex-attorney general, challenged putting the advertisement for the Exxon Valdez into the tariff and the state settled. SENATOR PEARCE commented that the state is paying for the advertising. SENATOR TAYLOR said that he believed the state was paying for all of the institutional advertisements. Number 560 MR. MESSENGER returned to the property tax which was enacted in the Special Session of 1973 in order to tax equipment and facilities related to exploration, production, and pipeline transportation. The tax wasn't applied to the value of the oil and gas in the ground, although other states do impose such a tax. He noted that there was one exception when the state enacted a reserves tax for a two year period in the years 1975 and 1976. That two year tax was on the value of the oil and gas reserves in the ground. Mr. Messenger pointed out that in 1975, the state's general fund was dwindling considerably and the pipeline wasn't scheduled to start production from the North Slope until 1977. In order to deal with the crisis, the legislature adopted the aforementioned reserves tax and allowed the companies to credit their current severance taxes or those in the future against the reserves tax. That reserves tax provided a bridge for the state during that difficult time. The reserves tax was initially set at 20 mills for the first year. He believed the legislation allowed the second year to establish a millage rate similar to a municipal millage rate in order to cover the budget for that year. Ultimately, the legislature provided that the millage would be 20 mills unless action was taken. The reserves tax was 20 mills in both 1975 and 1976. CHAIRMAN HALFORD understood then that the tax was a credit against the future severance tax on the resource. If the gas were produced, then it would be a nontax. MR. MESSENGER replied that Chairman Halford was correct. TAPE 99-7, SIDE B SENATOR TAYLOR commented that if a mill levy was assessed every year against oil reserves or properties based on the current fiscal gap in the general fund, the oil industry may be willing to cut the budget. SENATOR TAYLOR suggested that the committee eliminate the ELF and institute the separate accounting approach. CHAIRMAN HALFORD indicated the need for the leadership to request, from the Governor, an expansion of the call if such action is desired. Number 561 REPRESENTATIVE THERRIAULT thanked the committee for the information. He inquired as to the time line of this special committee as it attempts to interject the legislature's desire to protect Alaska and its citizens in this process. He noted that the Administration will possibly be moving forward and producing a package within the middle of October, when the legislature isn't in session. CHAIRMAN HALFORD stated that he believed the committee has arrived at the table in a way that no legislative committee ever has. He believed that the committee has good counsel and a good economist. Furthermore, the FTC appears willing and interested in talking with the committee. Chairman Halford noted that these meetings have occurred in order to obtain a sense of what members want with regard to the merger. This is the only option short of an expansion of the call or a resolution. SENATOR TAYLOR suggested the committee should take a poll and determine if the legislature would call itself back into session to take up this matter which is of such magnitude. REPRESENTATIVE GREEN agreed and believed any criticism over another special session would be worth it. REPRESENTATIVE DAVIES asked if there is anything that prevents the legislature from calling itself into another special session now. CHAIRMAN HALFORD informed everyone that the committee has a legal opinion that indicates that it would be difficult for the legislature to call itself into session while in a special session. Chairman Halford reiterated that the way to address the merger would be for the two presiding officers to go before the Governor and request the call be extended to the subject of the merger. If such is the will of the majority of the membership of both houses, then that request should be made. Short of that scenario, much can be achieved by asking questions. REPRESENTATIVE THERRIAULT pointed out that although the FTC doesn't care about the timing, negotiations with the companies can occur regarding reduced tariffs. However, that negotiating leverage will likely be unavailable by the time the legislature returns. CHAIRMAN HALFORD stressed that "this leverage" will be available. He said that we should continue to want the state's fair share with as much competition as possible. Without competition, there would be a regulatory structure that would be beyond the legislature's capacity to understand, manipulate, and control in order to protect a small operator's ability to operate. REPRESENTATIVE THERRIAULT stated: If one of the goals is we do want to have a very competitive environment, and all we do is rely on taxation without using the opportunity to get (indisc.- multiple speakers) we potentially lose the opportunity and lower the tariffs which would increase competition. ... So that does not help us. CHAIRMAN HALFORD agreed. However, there are ways for the state to obtain a benefit. Lowering the tariff helps the companies and the state, although there are different things that hurt the companies and the state. SENATOR TAYLOR indicated that it would be premature to follow that, but in the next few weeks there would have to be a decision. CHAIRMAN HALFORD commented that the Governor may return with a proposal for which the committee would want to request formal action and take a formal position for the FTC. Number 489 REPRESENTATIVE KERTTULA said that would be at a minimum. She noted that it is difficult to negotiate after a deal is cut. The committee has had some strong assurances with regard to bringing anti-trust cases, if necessary. Although the FTC may hold out, there is value for the committee to be personally involved while there is interest. She also mentioned the involvement as helpful in that it provides background information for the FTC. Representative Kerttula agreed that the magnitude of the merger is huge. REPRESENTATIVE CISSNA inquired as to the options that would help strengthen the committee's bargaining position. Can the committee simply survey the legislature? CHAIRMAN HALFORD noted that in his time with the legislature, he has not seen a subpoena issued by a committee of the legislature. This committee has issued a subpoena in order to obtain the information. He also noted that the resolution creating the committee said the committee should do whatever necessary. However, once actions are taken the opponents of the actions would counter by saying the committee is acting out of session with no authority. The opponents would further counter that the committee isn't expressing the legislature's position or the state's position. Chairman Halford believed that the more authority and the more formal the authority, the more strength a body has. The question is how much is necessary. If the committee takes a tough position and receives "heat" for it, then the entire legislature would need to come together. REPRESENTATIVE CISSNA inquired as to the specifics that would strengthen the committee in the coming weeks. CHAIRMAN HALFORD reiterated that the Governor could be approached with regard to expanding the call, the legislature could send a resolution or a letter requesting the Governor's proposal be formally before the legislature for action. The legislature could adopt a resolution which points out the significance of this merger and speak to the procedures of the FTC. Chairman Halford believed the entry level to be for the Governor to agree with a formal ability to take up the issues which could actually enhance the Governor's position. This is not a matter of the legislature versus the Governor. CHAIRMAN HALFORD, in response to Representative Kerttula, reiterated that Senator Pearce had requested a legal opinion regarding if the merger issue could be added to the call. The opinion indicated that the simplest approach would be to adjourn from this special session and then the legislature call itself back for another special session. He noted that there is some need to avoid criticism that the merger is a way to avoid subsistence. The scheduling of this meeting has to stay behind the subject of this special session. SENATOR PEARCE informed everyone that the House set a precedent in 1994. Taking time to argue whether action was taken in the appropriate place, takes away from the issue. REPRESENTATIVE DAVIES commented that if the legislature unanimously passed a resolution, then who would care. CHAIRMAN HALFORD explained that the enforcement mechanism for the call is to invalidate a law. A resolution doesn't have the power of law. He indicated the need to do it right. He couldn't believe that the Governor would refuse an expansion of the call, if both presiding officers approached him on the matter. However, that conclusion hasn't been reached yet. REPRESENTATIVE CISSNA asked if the committee has any concept of the timing on that readiness. REPRESENTATIVE KERTTULA answered, perhaps a week. The review of the documents and analysis has been proceeding quickly. The committee is close to determining the appropriate path. She noted that the Administration has cooperated as much as it legitimately can. All of this is difficult, under these time constraints. CHAIRMAN HALFORD adjourned the Joint Special Committee on Mergers at 6:10 p.m.