SENATE RESOURCES COMMITTEE March 17, 1995 3:55 P.M. MEMBERS PRESENT Senator Loren Leman, Chairman Senator Drue Pearce, Vice Chairman Senator Steve Frank Senator Robin Taylor Senator Lyman Hoffman COMMITTEE MEMBERS ABSENT Senator Rick Halford Senator Georgianna Lincoln COMMITTEE CALENDAR SENATE BILL NO. 114 "An Act relating to high cost marginal oil wells." CS FOR SENATE BILL NO. 16(CRA) "An Act relating to the University of Alaska and university land, authorizing the University of Alaska to select additional state public domain land, and defining net income from the University of Alaska's endowment trust fund as 'university receipts' subject to prior legislative appropriation." SENATE BILL NO. 112 "An Act establishing a discovery royalty credit for the lessees of state land drilling exploratory wells and making the first discovery of oil or gas in commercial quantities." PREVIOUS ACTION SB 114 - See Resources minutes dated 3/8/95 and 3/17/95. SB 16 - See Community & Regional Affairs minutes dated 2/20/95. See Resources minutes dated 3/10/95 and 3/17/95. SB 112 - See Resources minutes dated 3/08/95, 3/10/95, 3/17/95. WITNESS REGISTER Dr. Charles Logsdon, Chief Oil Economist Department of Revenue 550 W. 7th Ave., Suite 570 Anchorage, AK 99501-3557 POSITION STATEMENT: Gave briefing on high cost marginal oil wells and Alaska's economic limit factor for severance tax. David Johnston, Chairman Alaska Oil and Gas Conservation Commission 320 Mariner Dr. Anchorage, AK 99515 POSITION STATEMENT: Commented on SB 114 Brad Penn Marathon Oil 3201 C Street Anchorage, AK POSITION STATEMENT: Commented on SB 114. Deborah Vogt, Deputy Commissioner Department of Revenue P.O. Box 110400 Juneau, AK 99811-0400 POSITION STATEMENT: Commented on SB 114. Bill Van Dyke Division of Oil and Gas 3601 C Street, Ste 1380 Anchorage, AK 99503-5948 POSITION STATEMENT: ACTION NARRATIVE TAPE 95-23, SIDE A Number 001 SRES 3/17/95 SB 114 HIGH COST MARGINAL OIL WELLS  CHAIRMAN LEMAN called the Senate Resources Committee meeting to order at 3:55 p.m. and announced SB 114 to be up for consideration. CHUCK LOGSDON, Chief, Department of Revenue Petroleum Economist, briefed the committee on high cost marginal wells and Alaska's severance tax. The severance tax is levied on all barrels of oil produced in the State of Alaska. The tax is calculated on a field by field basis by multiplying the number of barrels of non-royalty oil by the wellhead price multiplied by the tax rate (either 15% or 12.25% depending on the age of the field) by the economic limit factor (ELF). The ELF is specifically designed to recognize the productivity of each field that is severance taxed. It has a value that ranges between zero and almost one. It can never be one. This means that you take the value of production times the tax rate which results in a percentage reduction in that total calculation based on how productive the field is. For instance, if the ELF was 0, 0 times 0 is 0, and you wouldn't pay any severance tax at all. SENATOR FRANK asked how wellhead is calculated. DR. LOGSDON clarified that just transportation costs to the point of sale are deducted. He said that the appropriate wellhead value is something that the state and oil companies have fought about ever since Prudhoe Bay came on line. There is no field cost allowance on the severance tax side, but there is on the royalty side. There is an allowance for gathering and dehydrating for most of the fields. DR. LOGSDON illustrated the formula before the committee for clearer understanding. He said you could also characterize the ELF as a percentage reduction in the total tax as calculated by wellhead and rate. You could also think of it as a percentage reduction in the number of barrels that pay the maximum rate. The ELF does provide considerable tax relief to the marginal wells and small oil fields. He explained that the ELF reduces the severance tax rate as both per well and overall field wide production declines. The bigger the field and the better the wells, the higher the tax. The first 300 barrels produced out of every well are tax free. The way it's designed there are tax benefits to small oil fields. Most fields (not barrels) in Alaska pay $0 severance tax. At this point Dr. Logsdon explained some graphs he handed to the committee titled: "Alaska Severance Tax Summary Table," "Economic Limit Factor," "Field Size and ELF," and "Shrinking Piece of Shrinking Pie." On the ELF formula, itself, he said it was easier to understand if you break it into two parts: ELF = (1 - 300/WP) - WP is the average production per well in an oil field. He explained the reason the first 300 barrels are tax free is because if the average well produces 300 barrels a day and you substitute 300 and you get 300 over 300 which is 1 and 1 - 1 is 0 and 0 times 0 is 0. So if the field averaged only 300 barrels a day per well, there would be a $0 ELF and there would be no severance tax. The second part of the formula is ^(150,00/TP)^1.5333) or the field size adjustment. TP is the total daily production from the field. As field size decreases, it pushes the ELF down for a thousand barrels per well per day. As the field size increases the field size factor makes the ELF go up. DR. LOGSDON said that only about five of the roughly 21 producing Alaska fields pay any oil severance tax. The tax rate is now falling. If you were to apply the same ELF that was applied in 1990 to 1994 production, the industry would have paid an additional $9.4 million in taxes. That is the tax benefit measured if the ELF would have been frozen in at the 1990 rate. Number 348 DR. LOGSDON said for the future, because the production tax rate will fall as production falls, at some point in time every aspect of the formula will fall. On the severance tax side, a few years in the future we will be getting a shrinking piece of a shrinking pie. Number 394 SENATOR FRANK asked what the picture looked like on royalty. DR. LOGSDON answered that there isn't an ELF concept on the royalty side. Every field pays what the lease terms were. On the field cost issue, he said, that allowance is a fixed amount that's adjusted for inflation. Number 437 SENATOR FRANK commented that royalty, then, would be a constant piece of a shrinking pie. DR. LOGSDON agreed. SENATOR FRANK noted that there is the corporate oil and gas tax and asked if that apportioned world wide profits. DR. LOGSDON answered that it did. He said it's difficult to say if that tax would shrink with the pie, so to speak, because it depends on how much off setting activity there is. DAVID JOHNSTON, Chairman, Alaska Oil and Gas Conservation Commission, said this bill would encourage continued production of the high cost marginal wells. It would probably also return some currently shut down wells to production. It might make Alaska a more competitive place to do business. To put it in perspective, he said, this bill would make the price of oil for marginal wells $19 per barrel instead of the going rate of $17. In the Cook Inlet Region, basically 41 wells would qualify. Total production out of those wells is a shade under 700,000 barrels. A two dollars per barrel credit would cost the state $1.4 million. He said it was harder to estimate how many wells would be returned to production under this legislation, although he thought there would be some additional production. There are a few wells on the North Slope that would derive some benefit, but in 1994 only six wells would qualify, MR. JOHNSTON said. Historically, 28 wells would have qualified in 1990, 33 wells in 1991, 28 in 1992, 32 in 1993. Production numbers range anywhere from just under 400,000 in 1990 up to 630,000 in 1991, and 560,000 in 1992. MR. JOHNSTON said that SB 114 is a modest proposal not costing the state much money - about $5 million per year in credits. It would keep some wells in production that would continue to pay a royalty. This bill will better ensure the royalties will continue to be realized by the state. Number 516 He suggested deleting language on page 2, line 22 and just go with the $1,000,000 per well or the $5,000,000 per producer. Otherwise the language would essentially do nothing. SENATOR LEMAN asked if his fiscal analysis of SB 114 was based on the assumption that that particular section is deleted. MR. JOHNSTON answered yes. Number 555 SENATOR FRANK asked if these wells pay a severance tax. MR. JOHNSTON said they didn't. SENATOR FRANK asked if it was just reducing a royalty payment. MR. JOHNSTONE said he understood it to mean that it would keep these wells producing and we would be getting 12.50% royalties on that production. On a 100 barrel well that would net approximately $125 back to the state, but it would cost us $200 in credits. You could offset that with some royalties that would possibly be lost in the absence of these credits. MR. JOHNSTON said that SB 114 is just one approach to encourage production. He thought reducing the royalty would be like bringing a sledge hammer to bear against the problem. Number 571 SENATOR LEMAN asked him to explain the transferable tax credits on page 3, line 2. MR. JOHNSTON explained that you may receive credits, but not have any severance tax to apply it to in which case the credit could be sold to another producer who does have a tax obligation, or wants to purchase leases, or has a field he wants to develop that would have a higher ELF. TAPE 95-23, SIDE B SENATOR LEMAN asked if it would be possible for the legislature to require that there be benefit to the state in a transaction like that. MR. JOHNSTON said that wouldn't necessarily be anything the state would be concerned with, that it's just a commodity for producers to sell or purchase. SENATOR FRANK said it seemed like we are subsidizing production and he was more interested in subsidizing exploration activities so we could increase profitable production. He didn't really support taking money out of the treasury to keep a well in production if that's what is being proposed. MR. JOHNSTON agreed that exploration should be encouraged, but this is just a tool to ensure that the production we do have, especially in the Cook Inlet, remains on stream. He thought this would be economically significant to the people who live on the Kenai Peninsula. SENATOR HOFFMAN said, looking at the fiscal note, it looks like it would cost the state $1.1 million through 2001 and asked what the benefits would be in terms of jobs and the total annual salary that would be gained by keeping up the production of these fields as a result of the legislation. MR. JOHNSTON said he didn't have that information. He thought the operators in Cook Inlet would have a good idea. Number 494 BRAD PENN, Marathon Oil, explained that the credits are not a payment out of the treasury; it's just a reduction of what would be coming in if these wells are kept in production. SENATOR LEMAN said that possibly the credits should be limited to those similar type projects. MR. PENN said, theoretically, you might be able to assign a credit to someone who wants to bid on leases and drill an exploratory well with up front royalties. DEBORAH VOGT, Department of Revenue, pointed out that the fiscal note needed revision if subsection (a) of b (2) was deleted. Number 446 SRES 3/16/95 SB 16 INCREASE LAND GRANT TO UNIV. OF ALASKA  SENATOR LEMAN announced SB 16 to be up for consideration. SENATOR FRANK moved to pass SB 16 from committee with individual recommendations and asked for unanimous consent. There were no objections and it was so ordered. SRES 3/16/95 SB 112 DISCOVERY ROYALTY CREDIT SENATOR LEMAN announced SB 112 to be up for consideration. SENATOR LEMAN announced an at ease from 4:55 - 5:07 p.m. Number 428 KEN BOYD, Acting Director, Division of Oil and Gas, said that there has been a discovery royalty in statute since statehood. The term "geologic structure" has been used by the United States Geologic Survey since 1920 for oil and gas purposes. From 1937 - 1958 this term was used to establish reduced royalties on non-competitive leases under regulations implementing the Alaska Oil Proviso of the Federal Mineral Leasing Act of 1920. The Oil Proviso authorizes the Secretary of the Department of the Interior to establish special royalty rates on leases issued in the State of Alaska to encourage oil and gas development. MR. BOYD said that in 1959 Alaska became a state and the oil and gas resource was thought to be the best avenue for getting revenues. And it worked well. In 1969 the discovery royalty statute was abolished, because all the major oil fields were in production and it wasn't needed any more. Cook Inlet had been discovered and Prudhoe Bay was just being sold for over $900,000,000 in bonuses. Now production is declining, MR. BOYD said, and perhaps a discovery royalty is needed to bring back new explorers. SENATOR LEMAN said maybe they could clarify the application of discovery oil credit by specifying time or distance rather than using the term "geologic structure. " BILL VAN DYKE, Division of Oil and Gas, said that would be possible. The old royalty provisions show that they were effective in getting people out there early to try to be the first to discover, but there were some nasty arguments over what constitutes a known geologic structure and who discovered what reservoir first. SENATOR FRANK asked if the idea was to reduce the royalty from 12.5% to 5% for a period of 10 years for the first well discovered in a newly discovered geologic structure. MR. VAN DYKE answered that was his understanding. SENATOR FRANK asked if Lisburne, Kuparuk, Prudhoe, etc. were separate geologic structures. MR. VAN DYKE said that Prudhoe and Lisburne would be considered the same geologic structure. SENATOR FRANK said there was some criticism of the bill, because the commissioner has more discretion he could possibly abuse . MR. VAN DYKE explained that history shows that where you have a number of separate geologic structures very close to each other, people can disagree as to whether it's one big geologic structure or whether it's different geologic structures. Number 291 SENATOR LEMAN noted that he thought the drafter, Mr. Chenoweth, in drafting this legislation merely restored language from 1969 and he thought that a lot had been learned since then that needed to be applied to current legislation to keep the state out of continued litigation. SENATOR LEMAN asked if the reduced royalty applies to the discovery well or to the entire lease on which the first well is located. He thought the language meant the entire lease. MR. VAN DYKE said the old law applied to all production from the lease. He added that a field covers more than one lease usually. SENATOR LEMAN asked if it were limited to just the one well, it probably wouldn't be a substantial enough incentive. MR. VAN DYKE answered that was right. SENATOR FRANK asked if some units had many leases. MR. VAN DYKE said that Prudhoe has over 100. SENATOR FRANK asked if the reduction was applied to just one lease, would that be a significant incentive. MR. VAN DYKE replied that it has been in the past. Number 142 SENATOR FRANK asked if you could have enough production out of one lease to make an oil field economically viable. MR. VAN DYKE said that was almost impossible on the North Slope. SENATOR FRANK asked how many uneconomical pools of oil have been found on the North Slope. He wanted to know if the tax structure made it unviable. MR. VAN DYKE said there was currently only about a half dozen decent sized pools that are still "shut in" as uneconomic. SENATOR FRANK asked if the state was trying to spur activity on leases that have already been issued or is a long term policy being established to increase the chances of the state leasing more. MR. VAN DYKE answered that it would be nice to get some activity on some leases that have been issued in the last couple of years which haven't been drilled, yet, in addition to getting more activity on leases that will be issued in the next few years. He explained that North Slope leases are mostly issued for 10 years. SENATOR LEMAN asked how we have some leases from the old discovery days that are still not developed, but could still possibly apply if the leases are for 10 years. MR. VAN DYKE said some of them have not been developed, because the state has yet to receive title to the land under those leases; they're called conditional leases. Others are in unit areas which get extended. Number 128 SENATOR LEMAN thanked everyone for their participation and adjourned the meeting at 5:30 p.m.