Oil and gas consultant urges tax simplicity, preserving deductions

The Legislature’s new consultant took the ongoing oil tax and credit debate in a new direction that momentarily eased partisan stances.

Instead of approving or denouncing the oil production tax changes proposed in the House Resources Committee, Rich Ruggiero, managing partner of the petroleum consultant firm Castle Gap Advisors repeatedly emphasized a need to abridge the contentious tax when providing advice to legislators.

“If I were to give you a recommendation from afar, it’s to simplify (the production tax),” Ruggiero said.

A longtime oil industry engineer and service company executive, Ruggiero said Alaska’s net profits production tax is among the most complex systems with as many moving parts as any like tax system he’s studied worldwide.

A simpler system with self-correcting mechanisms could be employed to achieve a number of goals while at the same time alleviating many of the “friction points” that currently face industry and the state, he said further.

Albeit a very general suggestion, Ruggiero appeared find common ground among those entrenched in the often partisan and omnipresent debate.

Resource Co-chair Rep. Andy Josephson, D-Anchorage, noted in an interview that oil tax disputes — in court and the Legislature — long predate the current tax law, but added Ruggiero’s point was “well taken.”

Josephson and Resources Co-chair Rep. Geran Tarr, D-Anchorage, put forth House Bill 111 in early February. Democrats and moderate Republicans in the House Majority have touted the bill for its measures to eliminate directly cashable tax credits for North Slope operators, a primary component of their path to balance the state budget.

Alaska’s North Slope oil tax policy is a “reflection of urgency and the fear of loss of production,” Josephson said, that led to the overlay of complex mechanisms intended to incentivize companies to come to Alaska and ultimately spur oil production.

Josephson is well versed in the details of the production tax having been deeply involved last year in the evaluation of House Bill 247, which drastically reduced the state’s oil and gas tax credit program.

Alaska’s current North Slope production tax is the greater amount of either a 35 percent net tax on all producer profits or a minimum gross tax of 4 percent. Under current policy the gross tax applies at prices roughly less than $75 per barrel.

If left alone, the 35 percent base rate would be among the higher petroleum severance tax rates, particularly for a high-cost basin such as Alaska.

However, on the state’s oldest, and to this point largest, fields, negative progressivity is employed through a “per barrel” credit, which deducts up to $8 from production taxes at prices less than $80 per barrel, decreasing by $1 for each $10 increase in price before reaching zero at $140 per barrel.

Newer fields conversely get a fixed $5 per barrel value deduction regardless of price. The $5 credit can be applied against the minimum tax, which converts to a gross tax, at low prices.

“New oil” is also eligible for a gross value reduction, or GVR, credit that reduces its base taxable value generally by 20 percent.

The GVR was originally a continuous provision but HB 247 now limits it to the first seven years of production from a new field or until the average Alaska North Slope oil price exceeds $70 per barrel for three years, consecutive or not.

After those calculations are complete a company can apply deductions equal to 35 percent of operating losses incurred before production begins or during periods of severely depressed prices.

The layers of deductions in the system that can be a gross or net tax depending on oil price are a mixture of new provisions and those left from the state’s previous oil tax laws, Ruggiero observed.

State tax officials have said the intricacies of the tax are one of the reasons it can take five years or more for the state to complete a production tax audit.

Resources member Rep. Chris Birch, R-Anchorage, concurred that a simpler tax system would likely alleviate some of the unintended consequences that complexity inherently brings.

He said in an interview that he would support trying to get to a more straightforward production tax but acknowledged getting there without becoming consumed by what is an appropriate or fair tax rate would be nearly impossible.

At least for now, the House Resources leaders are focused on tax credits and not overhauling the fundamental tax structure.

Birch is also quick to point out at every opportunity that HB 111 is also a general tax increase on industry as well as a credit cutter.

“I would be thrilled to see HB 111 disappear and let’s talk credits,” Birch said.

A House Minority Republican, Birch questioned the wisdom of cashable credits that in essence make the state a direct investor, willing or not, in the often risky business of oil exploration.

“You can do far more to advance investment by having a stable tax policy,” he said.

Alaska Oil and Gas Association CEO Kara Moriarty said it is understandable why some people view it as a complex system but it does not preclude companies from running accurate economic modeling for projects.

She said the previous Alaska’s Clear and Equitable Share, or ACES, law was at least as complex as the current system. Moriarty added that some provisions in HB 111 would complicate things further by making what is now an annual tax with monthly estimates ostensibly a monthly tax to limit when companies can apply per barrel credits.

Ruggiero stressed the need to prioritize a durable tax, a feature Tarr has often said is lacking in the current system, as it was not vetted at low prices, she notes as well.

A net profits-based system ideally taxes based on profits, not oil price, according to Ruggiero.

He described a marginal progressive tax with brackets more resembling the base federal personal income tax than Alaska’s price-bound system.

A marginal profits tax intrinsically adjusts to market forces and production and transportation costs, Ruggiero said, the latter of which can change greatly in Alaska and don’t always reflect changes in oil prices.

He noted that the state’s gross minimum tax rates correlated to low prices were adopted when production and transportation costs were less than half of what they are today.

Part of that is due to less production leading to higher pipeline tariffs and part is likely the result of other market dynamics, he said.

The downside of a profits tax from the government side is that it at the mercy of producer costs before it taxes.

To that end, Ruggiero said industry service companies “get squeezed tremendously when prices go down and take the opportunity when prices are up to fill their bank accounts back up a little bit,” which contributes to increased field costs when prices are high.

However, he added that competition within a producer company’s ranks will quickly weed out individuals who do not utilize cost-cutting efficiencies.

Specifically to HB 111, Ruggiero said the desire to add revenue is understandable given the state’s budget situation. He characterized the tax increase — immediately about $60 million per year growing to more than $100 million based on Revenue Department projections — as a relatively “minor movement,” but quickly noted that “it won’t go unnoticed” by industry.

The Revenue Department estimates the tax increases and credit reductions in the bill would have a cumulative net positive of about $200 million per year to the state budget after its provisions take full effect.

Credit options

While HB 111 would end refundable tax credits for North Slope operators and cut the deductible operating loss percentage from 35 percent to 15 percent, Tarr and Josephson have said repeatedly they want to find other ways to attract activity to the basin other than directly subsidizing a company’s work.

Josephson acknowledges the change as “massively significant” to Slope explorers with little to no operating cash flow but has also insisted he wants to find a way for the state to start paying down its existing credit obligation, which Revenue officials estimate is likely to be nearly $1 billion by the end of fiscal year 2018.

Meanwhile, lawmakers are also trying to navigate through another nearly $3 billion budget deficit for 2018.

Ruggiero said Alaska’s cash tax credit program is unusual among oil and gas tax systems. At the same time he highlighted the importance of retaining, and possibly increasing, the ability for companies to claim NOL or carry forward annual loss credits.

Industry sources have also emphasized the need to keep losses deductible — a very common tax provision — at or near the current 35 percent level on the recognition cashable credits are on the way out.

Ruggiero suggested providing a form of uplift to increase the percentage value of an operating loss each year. Adding a small percentage yearly to an operating loss incurred for exploration or development activities maintains the value of the loss deduction over time, particularly in a basin with unavoidably long development timelines such as the Slope, he said.

An uplift period that ends after several years can also be a tool to spur quicker production. That’s because the sooner a company gets a field into production and generates a production tax liability to apply the uplifted NOL, the greater value that NOL has.

It is a compromise that can for the state get oil — and royalty payments — flowing sooner, while allowing the company to maximize the value of its tax deductions, Ruggiero described.

“Whenever you have a net (tax) system you cannot get away from the fact that the state becomes an indirect investor in every project,” he said.

Josephson said he is interested in the options such incentives could provide companies without obligating the state to write more checks.

Moriarty said Ruggiero’s concepts regarding deductible NOLs are in line with industry’s stance, emphasizing the importance of not reducing the deductible rate — currently a match to the base tax rate.

Ruggiero added the one instance the state might want to keep cashable credits on the table is when a company has a carefully planned exploration project that ends up with a “dry hole.” In that case the state’s technical experts could evaluate the exploration work and the state would pay a portion of the company’s expenses in Alaska once the leases were relinquished.

He said it is not paying a company for leaving, but rather paying them for coming to Alaska with the recognition that the state is a high-cost place to do business and even the best exploration programs do not always pan out.

Elwood Brehmer can be reached at [email protected].

03/09/2017 - 2:23pm