Legislators on both sides agreed ACES needed changes
Former Alaska Gov. Tony Knowles, a Democrat, speaks at a rally calling for changes in Alaska’s oil tax structure on Feb. 23, 2011, in Anchorage. Current Republican Gov. Sean Parnell completed Palin’s term after she resigned in 2009, and after winning election in 2010 he announced he wanted to reform the oil tax structure known as ACES to encourage additional investment and production on the North Slope.
Alaska’s previous oil tax, known as ACES, was passed in 2007.
By 2009 and 2010, it was widely agreed — by Democrats as well as Republicans in the Legislature — that changes were needed.
There were disagreements over what the changes should be, but it was generally accepted that the tax had become dysfunctional.
Why was that?
A complicated, unpredictable tax
First, the ACES tax was extremely complicated, and difficult for companies to understand. In and of itself this was a big barrier for firms interested in coming to Alaska. Other states, like Texas and North Dakota, have simpler taxes.
Second, ACES’ effects were unpredictable, and short-term swings in crude oil prices could cause the tax rates to vary widely. Under ACES, the tax had to be calculated every month, so month-to-month variations in prices could play havoc with a company’s best effort to predict its tax payment for the year.
In January 2009, one North Slope producer estimated its average tax rate for the year at 15 percent. Six months later it was 50 percent, increasing only because of swings in world oil prices.
Another problem was that a tax rate change under ACES subjected all of a company’s earnings on oil production to the changed tax. It wasn’t like the federal income tax where tax rates on income are bracketed.
Bruce Tangeman, former state Deputy Revenue Commissioner for Tax, said he believes the instability and unpredictability of the ACES tax was its biggest problem and not so much the high tax rates.
“Oil producers are used to paying high taxes, but they want them to be stable and consistent. The ‘progressivity’ formula in our tax made it perform in ways that were just wacky. It really made us unattractive,” Tangeman said.
Back luck on timing
Mike Pawlowski, currently a Deputy Revenue Commissioner, said Alaska also suffered some very bad luck with timing when ACES was enacted.
“When the Legislature was considering ACES in 2007 there seemed to be a very limited competitive environment,” or other places companies could invest, he said. That perception, held by everyone at the time, shaped legislators’ decisions.
In 2008, the competitive world changed, unexpectedly, in ways few in industry and no one in Alaska saw coming. Shale oil development in Texas and North Dakota took off along with activity in Alberta, Canada, and suddenly Alaska wasn’t looking so good.
“As oil prices went off our situation became worse, because the ACES tax rates climbed and made us look worse and worse compared with those other places,” Pawlowski said.
Pawlowski said Alaskan activity was getting no lift from high oil prices through 2010 and 2011 while those other states were booming, but what was particularly striking is that the tax disadvantage was enough to overcome the huge advantage Alaska has in transporting oil through a well-established pipeline and tanker transportation system compared with the bottlenecks faced by North Dakota producers.
Companies were willing to pay the costs of transporting oil by rail and even truck rather than come to Alaska, he said.
High-cost projects subsidized, efficient wells penalized
Tangeman said one of the worst attributes of ACES, however, was how it subsidized high-cost drilling and production that would pay little or no production tax with direct state payments, while the tax was increased on conventional, or “light” oil, which did pay taxes.
This came about mainly because of a 20 percent capital investment tax credit in ACES that allowed companies a dollar-for-dollar tax credit on one-fifth of all capital investments, for whatever reason.
In the case of a high-cost project like shale oil or heavy oil, both of which are being pursued on the North Slope, there were scenarios where the state would actually lose money, where there would be effectively no production tax and where the state front-end subsidy would be more than the royalty revenue that could be expected.
The capital investment tax credit was applied to all kinds of investments, not just those linked to production, Tangeman said.
“The cost of repaving an airport runway would be partly paid by the state, and while that may improve the efficiency of support operations it wouldn’t result in one new barrel of production,” he said.
Pawlowski cited another example with Point Thomson, the large gas and liquid condensate field east of Prudhoe Bay now being developed by ExxonMobil Corp.
It is an expensive project, at $4 billion capital cost, and if ACES were in effect the state would pay 20 percent of the cost, or $800 million.
Yet Point Thomson will produce only 10,000 barrels a day of liquids, at least in the near-term, so the state’s $800 million investment would result in a huge loss compared with the revenues received from production.
ExxonMobil and its partners, which include BP, have other reasons for developing Point Thomson, including as a settlement of litigation and the first phase of a large gas project. But it is not a conventional commercial project that makes money.
One of the most important changes in SB 21 was to end the 20 percent capital investment tax credit and to replace it with tax credits linked to production so that companies would have to produce oil to get the credit, not just spend money, Pawlowski said.
Also, the capital investment tax credit was getting expensive for the state treasury. Had ACES remained in effect it would have resulted in several hundred million dollars per year per year in the state budget.
Nothing in ACES to encourage new oil
One final defect of ACES, in the view of Revenue officials and many legislators, was there was nothing in it to explicitly encourage development of new oil on the North Slope except for the imperfect 20 percent capital investment tax credit, which seemed to offer an ongoing capital subsidy, and exploration tax credits that were only for certain expenses.
Over the three years that tax changes were being considered, legislators seemed in wide agreement, even Democrats, that something for new oil should be part of the deal. Democrats including Rep. Les Gara, D-Anchorage, came in with their own specific proposals, and there were Democratic minority proposals for mechanisms to encourage new oil from producing fields.
In the heated closing days of the 2012 legislative session, under the Senate Democrat-Republican bi-partisan coalition, a bill passed aimed mainly at encouraging new oil.
The House did not go along with the Senate proposal, however, because it did not contain enough to encourage new oil in the existing fields. A mechanism specifically aimed at new oil was to become a key part of SB 21 when it passed the Legislature in 2013.