SENATE RESOURCES COMMITTEE February 1, 1995 3:37 P.M. MEMBERS PRESENT Senator Loren Leman, Chairman Senator Drue Pearce, Vice Chairman Senator Steve Frank Senator Rick Halford Senator Robin Taylor Senator Georgianna Lincoln COMMITTEE MEMBERS ABSENT Senator Lyman Hoffman OTHER MEMBERS PRESENT Senator Judy Salo Senator Bert Sharp Representataive George Davies Representative Norman Rokeberg COMMITTEE CALENDAR Oil and Gas Incentives for Development and Production of Oil and Gas SENATE JOINT RESOLUTION NO. 6 Relating to federally held property in those states, including Alaska, admitted to the Union since 1846. PREVIOUS ACTION SJR 6 - No previous action to consider. WITNESS REGISTER Ken Thompson, President ARCO Alaska P.O. Box 100360 Anchorage, Ak. 99519 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Jim Palmer, Director External Affairs BP Exploration Alaska P.O. Box 196612 Anchorage, AK 99519 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Jim Branch, Alaska Production Manager Exxon Company, U.S.A. P.O. Box 196601 Anchorage, AK 99519 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Pete Nelson, Alaska Land Manager Texaco P.O. Box 7812 Universal City, CA 91608 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Kevin Tabler, Land Manager Alaska Business United UNOCAL P.O. Box 7600 Los Angeles, CA 90051 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Ralph Dartez, Production Manager Marathon Oil Co. P.O. box 196168 Anchorage, AK 99519 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Bernie Smith, Manager Alaska Government Affairs Tesoro P.O. Box 196272 Anchorage,AK 99519 POSITION STATEMENT: Briefed Committee on oil and gas incentives. Dave Lappi, President/Owner Lapp Resources Inc. 4900 Sportsman Dr. Anchorage, AK 99502 POSITION STATEMENT: Briefed Committee on oil and gas incentives. David Johnston, Chairman Alaska Oil & Gas Conservation Commission 121 W. Fireweed Lane, Suite 207 Anchorage, AK 99503-2035 POSITION STATEMENT: Briefed Committee on oil and gas incentives. John Landrum, Manager Phillips Alaska P.O. Drawer 66 Kenai, AK 99611 POSITION STATEMENT: Supported oil and gas incentives. Jim Eason, Director Division of Oil and Gas Department of Natural Resources P.O. Box 107304 Anchorage, AK 99510-7304 POSITION STATEMENT: Advised Committee in broad terms on oil and gas issues and thanked the legislators for all their past fruitful interactions with him in his capacity as Director. ACTION NARRATIVE TAPE 95-3, SIDE A Number 001 CHAIRMAN LEMAN called the Senate Resources Committee meeting to order at 3:37 p.m. and announced the hearing on oil and gas issues to be before the Committee. He said this is a follow up to the November 4 meeting where the Gaffney Cline and Associates report was discussed. KEN THOMPSON, President, ARCO, Inc., said his testimony is a condensed version of the written testimony he had given the Committee. He is testifying concerning ARCO's views on ways to improve communication and working relationships between the oil industry and the government and to suggest ideas that could make new oil and gas investments in Alaska more globally competitive. He said ARCO has recently settled longstanding tax disputes with the State of Alaska and had reached agreements which allow them to avoid the disputes in the future. As a result, his company and the government have formed more of a true partnership. He believes that Governor Knowles and the Legislature are sincere in wanting to work with ARCO. MR. Thompson said ARCO sees tremendous future opportunity in Alaska and they will continue to explore and invest in new development. ARCO's 5-year capital plan calls for $1 billion of new investment in Alaska. They also see potential incremental investments that could be added to their plan if they can be made more competitive with worldwide investment opportunities. He emphasized that he is not asking for tax or royalty changes on existing production from currently active reservoirs in Prudhoe Bay, Kuparuk, or Point McIntyre, because he knows the State of Alaska is depending on those revenues. He is asking that there be no new tax increases on the existing production considering that there have already been 13 tax increases since prior to Prudhoe Bay start-up. He urged that the oil industry and the government have more open communication and noted that is the single most important recommendation in the Gaffney-Cline report. A special committee with AOGA has come up with recommendations for industry and government to discuss, among them are: to not "cry wolf" to the State and to share information openly, to look for innovative options all can live with, to share a full range of information on new projects needed for more informed decision making. ARCO is actively bringing new exploration partners to Alaska and is currently seeking partners on seven high risk exploration projects on State leased lands here. Number 200 Mr. Thompson said he believes that royalty and tax changes for new investment projects are needed if they are to add incremental investments beyond those in their current 5-year plan. They are considering net profits concepts, variable royalty rates tied to oil prices and well production rates or field sizes. They would like to participate in an Oil and Gas Tax and Royalty Conference consisting of industry, the Legislature, and the administration, he said. Further encouragement might come from "project partnering" for specific projects which will not move forward without joint innovation between the state and the company. "Partnering" means using a mutual gains approach to reach beneficial goals. He used the United Kingdom as an example of how the partnering concept helped their declining production dramatically in the last eight years. Project partnering can move forward by the State continuing the process of developing a viable fiscal plan. They need to understand what Alaska's competition is doing to attract investment. He said ARCO could share information they have on investment incentives offered by 70 different countries. He also noted we must not lower environmental standards. In closing, Mr. Thompson said that ARCO Alaska has agreed to participate in a tax and royalty conference to discuss both tax laws and royalty changes when the governor and the Legislature convene one. ARCO will also continue to assist the congressional delegation in efforts to open ANWR to environmentally responsible oil and gas exploration and production. They are also supporting lifting the North Slope oil export ban. ARCO Alaska also has agreed to keep the state informed of their efforts to assess one of their largest potential resources in Alaska - natural gas. Mr. Thompson said ARCO would do its best to help create a better win/win partnership with the State where we share common goals to sustain economic development, more stabilized revenues, and more jobs. Number 323 SENATOR LINCOLN asked when the 5-year plan began and have they had them before and have they been on target. Mr. Thompson answered that the 5-year plan began in 1995. They have had 5-year plans in the past which have changed dramatically with oil prices. He said their plan is available to the Committee. Number 335 JIM PALMER, BP Exploration, said they expect to invest more than a half billion dollars in capital in Alaska. He cited why Alaska is disadvantaged in the fiercely competitive environment for scarce capital - remoteness, declining production, high transportation costs, restricted markets, state budget deficit, and a history of antagonism that exists between the industry and the State. Opportunities that do exist on the North Slope consist of marginal new oil fields or marginal projects within existing fields. Mr. Palmer said that industry and government must work together to compete globally for investment capital. Recently enacted tax regulations have helped to clarify how to value oil for tax purposes for companies that refine their own oil, but there is still vagueness 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 efforts to attract capital to Alaska. Additional measures are needed and BP is proposing a sliding scale royalty for the Badami discovery. Number 410 SENATOR LEMAN asked if their intent was for the state to receive at least as many proceeds from the Badami field under the sliding scale royalty proposal as it would under the current 12 1/2% system. Mr. Palmer said the intent was to get additional revenue for both of them - 100% of $0 is $0. Number 432 SENATOR HALFORD asked what under existing law would the severance tax be at Badami. Mr. Palmer answered that he understood it to be 12 1/2% for the first 5 years, and then 15% as modified by the ELF. Senator Halford asked how the modification of the ELF would affect the royalty. Mr. Palmer said it would not affect it at all, because they are two different schemes. SENATOR HALFORD asked how the ELF would modify the severance tax. Mr. Palmer answered it was modified by the production of the field. Senator Halford said he didn't disagree with making the system of taxation more profit sensitive, but he thought severance should be the focus, not royalty which would open a lot of issues, especially with the Permanent Fund. JIM EASON, Director, Division of Oil and Gas, commented that Badami reserves are unknown so it is impossible to tell at this stage what the severance tax would be. It could be $0 which he thinks is likely. Number 474 SENATOR PEARCE asked if the future investments he mentioned included moving forward on Badami. MR. PALMER said that part of it is, but most of it is in their Prudhoe, Kuparuk, and Milne Point productions. SENATOR PEARCE asked when the Keystone tanker fleet has to be replaced, would that capital investment come out of Alaska's portion of capital for the company? MR. PALMER said he thought that would come out of their Alaskan assets and said he would check on it. SENATOR FRANK asked if they had cost projections based on certain assumptions. MR. PALMER answered they do and that one of the assumptions is the price. If they would have done a Badami-like project a number of years ago, it would have been $700 - $800 million. Their charge is to get total development costs under $300 million. Number 503 SENATOR TAYLOR said he was encouraged by their discussion and was feeling more and more like a partner all the time. He hoped that like a true partnership both the liability and ownership would be shared. To continue talking about severance taxes is not really partners, he continued. Partners know what was spent and the cost of things. They are still reaping the benefits of a successful partnership 20 or 30 years into a field. Number 517 JIM BRANCH, Production Manager, Exxon Alaska, said three things the State could do to improve the current climate for the oil and gas industry are fiscal reform; tax and regulatory stability and clarity; and improved cooperation between the state and industry. He elaborated that fiscal reform through reevaluation of spending priorities and ultimate spending reductions should be the state's top concern. Also, the potential for unanticipated tax laws and regulations is very important. Inconsistent application of tax laws and regulations poses risk and reduces the likelihood of a project getting the go-ahead. Better cooperation and communication between the state and industry are necessary to avoid disputes that are debated through costly litigation. There should be an alternative process to resolve differences, he added. Incentives should be designed to generate incremental new developments or additional production from existing fields through increased recovery. They should not be too limited or too focused, but should generally be applicable to all members of industry, Mr. Branch advised. TAPE 95-3, SIDE B SENATOR LEMAN said the Committee would be happy to receive specific ideas for incentives as they are developed. Number 572 PETE NELSON, Texaco, said the recent administration lacked the appropriate policy to encourage industry to use favorable provisions. She cited two incidents between Texaco and the Division of Oil and Gas to illustrate her point. One was when the Division required Texaco to provide historical well data which Texaco was unable to obtain. Texaco applied for and was granted certification for exploration incentive credit for its Colville well in 1988. The Division of Oil and Gas is reconsidering its grant of the certification even though there are no provisions in the law or regulations to do so. The Division is attempting to void any credits Texaco has and require payment of $1.8 million including interest. MS. NELSON said Texaco appreciates the Committee's interest in the industry. Number 512 KEVIN TABLER, UNOCAL, said Cook Inlet is where their infrastructure base and manpower is best defined, although they do have working interests in fields on the North Slope, also. The Cook Inlet, with its mature and declining fields, low margin properties, high operating cost and regulatory uncertainty, creates a very challenging environment in which to stay profitable. He mentioned specifically changes in effluent discharge standards for platforms and facilities and requirements for tanker escorts that are under review at this time. Although these are federal guidelines, the state has significant input. Platform abandonment regulations are also under review at this time. Product price is sometimes the one factor that limits remaining development opportunities with marginal fields. Number 467 Relief for marginal fields in Cook Inlet in the form of reducing or eliminating the State's royalty could make them economically viable. Reducing royalty based on capital investment for other properties would create value for the state and industry. A sliding scale royalty structure tied to price, production or a combination of both should be considered. Number 452 New field development incentives should include reducing royalty rate or eliminating it until payout, allowing recovery of capital costs by the risk bearing parties before the state receives its royalty share, and tying the reduction in royalty rate to the amount of capital expenditure incurred. MR. TABLER urged the State to broaden the application of exploration incentive credits. Great movement in the right direction was achieved with SB 308 last year, he said. Additional legislation which will enhance the lease/sale process can provide stability and reliability for planning. Incentives and regulations pertaining to coalbed methane development should be encouraged as an area with huge potential, as this is a high risk venture. Review of existing statutes and regulations are needed to assess what alternatives are already in place and a new mind-set created in all departments throughout the state. Three issues significantly affect UNOCAL in the Cook Inlet - the Coast Guard is currently being urged by fishermen and conservation groups to impose requirements for tractor tugs and pilot vessels in the Inlet. Tugs would cost $5 million per tug per year. He thought there were other ways to address this issue through use of navigational aids. Another issue, Mr. Tabler said, is water quality. Revision of the State of Alaska Water Quality Regulations (phase I and II); EPA's Coastal Effluent Guidelines for Oil and Gas Industry and EPA's Cook Inlet/Gulf of Alaska General National Pollutant Discharge Elimination System permit is needed. The third issue that concerns UNOCAL is Platform and Pipeline Abandonment Regulations. On September 14, 1994, testimony was given during public hearing to support new regulations which would significantly reduce the cost of platform and pipeline abandonment. Number 363 SENATOR LEMAN asked how many of the 15 platforms mentioned were in the Kenai Peninsula Borough. MR. TABLER said they are all in the Borough. SENATOR SALO asked if they currently have to have a pilot on-board all their ships up the Inlet. MR. TABLER said they have hired pilots on board. Number 345 RALPH DARTEZ, Marathon Oil, said their wells are in the Cook Inlet area and that they are in mature fields. Since all of the major geologic formations had been explored and no new large discoveries made, he felt that field extensions in existing fields and small or moderate size exploration prospects were what they are looking at. Remaining investment opportunities in these mature fields are very sensitive to product price and the remaining field life. Platform and field abandonment is an area of uncertainty and needs to be clarified. Development of an independent appeals process for tax disputes could provide a means for reducing uncertainty for the taxpayer. Title 38 already delegates some authority to DNR to consider royalty reductions for fields where weak economics threaten the future life of the field. He thought this incentive should be aggressively pursued by the state. Regulatory pressure continues to be the major threat to the mature fields. Water and air quality regulations should be thoughtful and add value and not automatically exceed the federal requirements. Land access is Marathon's number 1 concern. They are very happy with the passage of SB 308 which gives some certainty to the lease/sale process. In summary, Mr. Tabler said, initiatives have to be developed that either stimulate growth or sustain what there is now. Development of an independent appeal process for tax disputes is also important. Tax credits and royalty suspensions could be more liberally applied for marginal fields or to stimulate more marginal new field developments. We need to preserve the certainty of SB 308 to ensure timely, dependable access to lands, he said. We need to ensure that statutes and regulations carefully consider the impact to industry and add value. Mr. Tabler urged the Legislature to work with the Administration to "scope" a framework for acceptable initiatives. Number 210 BERNIE SMITH, Tesoro Alaska Petroleum, said the company has a refinery in Kenai and is in negotiation with the Division of Oil and Gas over its state royalty contract. Since 1969, Tesoro has spent more than $236 million on capital improvements in Alaska. They employ directly 850 people and pay about $11 million annually in state and local taxes. The Legislature should try to give clear direction so that royalty gas and oil can be managed in a way that encourages in-state energy self-sufficiency. For example, royalty oil can't be exported unless its surplus in-state and non-competitive sales must be made that offers benefits to the citizens of the state. JOHN LANDRUM, Manager, Phillips Alaska, said in general he supported most of the comments made by other industry representatives. Number 139 DAVE LAPPI, Lapp Resources Inc., said he thought Alaskans have the unique opportunity of developing their resources for their own use. For example, he thought that many rural Alaska villages could be served by locally produced natural gas which would eliminate the villages need to transport large quantities of expensive imported diesel fuels. Natural gas would eliminate the need to clean up frequent oil spills and the expense of fixing and upgrading many of the fuel storage tanks now in the villages. Increasingly stringent emissions and air quality regulations would be easier to meet if gas were the primary fuel. Mr. Lappi commented that most of the gas acreage the state has is not under lease. He thought it important that interesting areas be explored through exploration licensing. He also thought the state would be better served by reducing the cost of the cash bonus bid and the annual rental payment and get the acreage into the hands of private explorers who can do something with it. Number 80 Mr. Lappi was also concerned with the "sudden death syndrome" which are provisions in the state's bidding, leasing, and annual rental and royalty payments procedures where if a payment is inadvertently missed by even a few hours, you can lose your entire interest in a lease. He thought this was overkill. Bonding requirements should be more competitive for small projects. Seismic surveys should be made public after 5 years or after the companies who shot the surveys relinquished their licenses pertaining to the survey. TAPE 95-4, SIDE A Number 001 Mr. Lappi noted that the Division of Oil and Gas, as well as most other divisions, seem to take an adversarial approach to their role in the industry rather than advocacy. The state should try to structure itself to become more of an advocate for the industry through regulation and permit reform. If Alaskans are going to be involved in the industry as owners and operators of the oil and gas fields, it would help to change the state's vending and commerce regulations so that venture capital for exploration would be easier to get. DAVID JOHNSTON, Chairman, Alaska Oil and Gas Conservation Commission, said the state should get serious about creating incentives and creating more of a partnership with industry. He mentioned royalty reductions, and more certainty and more timely permitting. Number 137 JIM EASON, Director, Division of Oil and Gas, expressed his "profound appreciation" to be able to appear before this committee and others and the Alaska Legislature to address these issues. On listening to the many speakers today, he said, he heard a number of themes that make up a tapestry he would like the committee to consider when looking at possible incentives. He urged them to look at the history of incentives the state has used and see how they have worked or haven't worked. Some of them, for various unforeseen reasons, didn't work very well or had "unintended consequences." He said there is a wealth of information to draw from in other jurisdictions as with Ken Thompson and ARCO's study. Mr. Eason noted there had been a lot of talk about disincentives, but very little factual information has been shown for them to allow them to make a reasonable comparison of royalty and tax rates across those jurisdictions. He said information was their greatest ally. There was a large group of interests at stake here, from the smallest independent to the largest capitalized integrated oil company in the world. They also have a wide range of interests. It has been a constant theme to "bring new blood to Alaska." Number 238 SENATOR LEMAN asked him for his thoughts on any legislative changes he might have and thanked him for working with the Committee the past years. He said they would likely have follow-up meetings on these issues. SRES 2/1/95 SJR 6 TRANSFER FED. LAND TO POST-1846 STATES SENATOR TAYLOR, sponsor, said Gordon Harrison had researched this issue and as far back as 1802 the Federal Government started withholding, as new states would enter, some land. The only changes in the resolution were to change the date from 1846 to 1802 and to change the additional historic information within the body of the resolution. The bottom line is still the same, he said. All states should be treated equal. We have not been treated equal, nor have our sister states, to the extent that our lands have been withheld. This resolution calls upon Congress to make full fledged states of the Union out of each of the states that entered after 1802 and in particular those states entering in after 1846 which have the most significant amounts of federal property. SENATOR PEARCE moved to adopt the CS to SJR 6. There were no objections and it was so ordered. SENATOR PEARCE moved to discharge CSSJR 6 (RES) from Committee with individual recommendations. There were no objections and it was so ordered. Number 377 SENATOR LEMAN thanked everyone for their participation and adjourned the meeting at 5:33 p.m.