Senate rewrites House oil tax bill

JUNEAU — Senate Republicans have a new way to get the State of Alaska out from under its $700 million oil and gas tax credit obligation and it’s based on oil companies paying each other.

The Senate Resources Committee, chaired by Anchorage Republican Sen. Cathy Giessel, sent a version of House Bill 111 to the Senate Finance Committee on April 24 that would try expand the secondary credit market by allowing companies with additional, late-arriving production tax liabilities stemming from state audits to purchase unpaid credit certificates from small companies and apply them to the audit amount due.

The plan would require companies to accept their audit findings from the state without appeal to be eligible for applying purchased credits against their audited liability.

The hope is it can be a way for the state to settle its oil tax scores on both sides of the ledger.

Republican legislators have rarely missed an opportunity to criticize Gov. Bill Walker for vetoing $630 million in oil and gas tax credit payments over the past two fiscal years, but those on the Senate Resources Committee were more diplomatic with their comments in the April 24 hearing.

Walker vetoed appropriations to the state’s Oil and Gas Tax Credit Fund on the contention the state could no longer afford the industry incentive program while running annual budget deficits in the $3 billion range.

“The governor’s vetoes of the earned cashable credits in 2015 and 2016 exemplified the issue” of needing to end the ongoing liability, Giessel said.

While conservative Republicans contend low oil prices simply exposed bloated state budgets, Democrats jumped on the fact that current oil markets have turned the oil production tax and related tax credit program upside down.

Production tax revenue, which was more than $2.7 billion in fiscal year 2014, fell to $259 million in 2016, according to the Tax Division’s 2016 annual report.

“When oil was $100 per barrel (the annual credit payment) wasn’t so noticeable,” said Sen. Kevin Meyer, R-Anchorage. “When oil is $40 to $50 a barrel, it’s problematic.”

Before Walker’s partial veto, the Legislature appropriated $700 million to pay the refundable tax credits the state was estimated to owe in 2016 alone.

Some of the unpaid tax credit certificates held by small producers and explorers have been purchased at a discount by Alaska’s large volume producers — BP, ConocoPhillips, ExxonMobil and Hilcorp Energy — to apply against their annual production taxes and the Senate Resources version of HB 111 would try to build on that.

“For the small producers, they can make money now,” Sen. Natasha von Imhof said of the tax audit liability-repurchase option.

“It will not solve the problem tomorrow or next year but it begins the process of removing that liability,” Giessel added.

Production tax revenue from audits of producers’ prior tax years tax filings totaled $193 million this year, $132 million in 2016 and $264 million two years ago, according to Tax Division Director Ken Alper.

Tax audit revenue has historically been deposited in the Constitutional Budget Reserve Fund.

Underlying the push for production tax-paying companies to buy competitors’ credits is the elimination of the Oil and Gas Tax Credit Fund and eventually every oil-related cashable tax credit the state offers.

The Democrat-led House Majority and Senate Resources cut the refundable 35 percent Net Operating Loss, or NOL, credit, which many feared could put the state on the hook for billions of dollars in tax credits if recent large oil finds by Caelus Energy and the Repsol-Armstrong Energy partnership are developed, but left lesser-used credits for refineries, natural gas storage and Interior Alaska explorers in place.

Doing away with the refundable NOL would bring explorers and small producers that have earned cashable credits for years in line with the large North Slope producers that have not been eligible for the direct tax refunds but instead have deducted losses incurred from development projects or low price periods from their annual production taxes — a common tax practice.

The state’s current tax credit bill of about $700 million is expected to grow to about $1 billion by this time next year if the program is not cut in some fashion.

Senate Resources turned the “Middle Earth” exploration refundable credits into deductions against corporate income taxes, while the refinery and gas storage credits would still refundable until they expire, but that would require separate legislative appropriations.

Alaska Native corporations Doyon Ltd. and Ahtna Inc., in search of natural gas in their regions, are the primary companies to use the Middle Earth credits of late.

Giessel commented that completely scrapping the fund to pay the credits would prevent legislators from adding other credits in the future that could unintentionally balloon state expenses as the current program did.

The House Resources Committee, which spawned HB 111, included a new 15 percent refundable “dry hole” credit to help small companies offset the cost of well-prescribed but ultimately unsuccessful exploration programs. The after-the-fact dry hole credit was removed in later versions of the bill.

The Senate Resources Committee also added a 10 percent annual “uplift” provision to the 35 percent deductible NOL credit for up to seven years after the loss was incurred.

Some form of uplift was recommended by legislative consultants to help retain the real value of the tax deduction over time until a production tax liability is earned from a project and the deduction can be employed against taxes. The seven-year timeframe is a rough average of the time it takes to bring North Slope developments into production.

The Democrat-led House Majority said immediately after the 2016 elections that gave them control of the chamber that cutting oil tax credits was, and still is, a fundamental part of their plan to balance the state budget.

Republicans are often quick to note the program worked — in the end maybe too well — as it helped refill Southcentral Alaska’s natural gas stocks and brought new players to the Slope.

However, they, Walker, and even some industry leaders in the state have acknowledged the program as unsustainable.

House Bill 247, passed last year, will phase out Cook Inlet tax credits over the next couple years.

When HB 111 passed the House it did as much to overhaul the production tax as it did to end the credits and roughly doubled the effective tax rate at low prices on the largest North Slope oil fields.

It also included a “ring fencing” provision to tie operating losses to specific exploration or development projects as a way to make sure that losses incurred from one project can’t be used against the tax liability of another. Ring fencing is a way to protect the state from forgoing tax revenue if a project generates losses but never produces oil, according to House Democrats.

The Senate Resources Committee scrapped the tax increase and ring fencing sections of HB 111.

Many Republican legislators willing to curb tax credits have been adamant about leaving the underlying tax structure of Senate Bill 21 in place, pointing to current increased Slope oil production levels for the past two years as proof the tax is working for the long term.

“I’m glad this (version of HB 111) refocuses the attention where it needs to be,” Meyer said.

Wasilla Republican Sen. Shelly Hughes said the Senate is focused on the long-term revenue increased production will bring and not increasing taxes for a short-term gain.

House Resources Co-chair Andy Josephson, D-Anchorage, commended Senate Resources for the abolition of the cash credit program, which would take effect Jan. 1, 2018, noting it is a starting point for an overall fiscal compromise to end the extended legislative session.

“It’s great that we’re suspending or ending these cash credits because frankly we weren’t paying them anyway and so no one was prevailing under this system and those cash credits were not something that was sustainable,” Josephson said in the Majority’s April 25 press briefing.

But he said that he is “pretty gravely concerned” about the provisions the Senate committee pulled from the bill, adding “they’ve made significant changes to (HB) 111 that I don’t think my caucus will accept.”

Josephson, who has consistently harped on the need to pay off the credit obligation if a broader, long-term fiscal solution is reached, questioned the viability of relying on oil companies buying and selling the credits amongst each other to eliminate the state’s bill.

“My plan, and I think a place for settlement, would be to pay them faster than that,” he said.

The latest iteration of HB 111 also “hardens” the gross minimum 4 percent production tax floor on the large, legacy North Slope fields to prevent deductions from taking a producer’s liability below the minimum tax.

It amounts to a small tax increase, Giessel acknowledged, noting it was one of several conclusions drawn in a tax credit working group she formed in 2015 to evaluate the effectiveness of the program.

The minimum tax floor “is still flexible for new or small producers,” she added, that operate under different tax provisions.

Republican Resource Committee members Sen. John Coghill of Fairbanks and Bert Stedman of Sitka voiced concerns that the bill does not resolve a major point stressed by the Legislature’s oil industry consultants, that Alaska’s production tax, which varies between gross and net systems depending on the market price, is unnecessarily complex.

Castle Gap Advisors Managing Partner Rich Ruggiero repeated over many days of House and Senate committee testimony that the production tax with rates set on oil price and not profitability will likely need continuous adjustment as market conditions and production costs change.

“We did not address the complexity of our tax system and that’s probably going to be an issue for a long time,” Coghill commented.

Stedman added, “I would be hesitant to say Senate Bill 21 is a success when its important components are flawed.”

Elwood Brehmer can be reached at elwood.brehmer@alaskajournal.com.

Updated: 
04/25/2017 - 8:56pm

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