Legislators wrestle with complexity of oil tax reforms
JUNEAU — Legislators in Juneau are moving toward key decisions on changing the state’s oil and gas production taxes, the top priority for the 2013 legislative session aside from the budget.
At this point the Senate version of the bill is in the Senate Finance Committee, which held hearings over several days last week, after having passed out of two other committees. The House Resources Committee has held several hearings on the House version, but is mainly waiting for the Senate to pass its bill over.
There are five weeks left in the session before the April 15 scheduled adjournment, but it’s expected now that some form of the oil tax change will pass.
One reason for that is the new makeup of the Legislature this year, with Republicans who favor the tax changes in control of the Senate as well as the House.
What’s surprising, however, is that there seems a consensus this year, even among most Democrats, that some changes to the current law, known as Alaska’s Clear and Equitable Share, or ACES, are needed. It seems widely agreed now that stimulating new oil production is vital because of the continuing decline of the North Slope producing fields.
There even seems to be consensus on how much the tax should be reduced, a bottom-line question, at least in the Senate so far. Consultants to the Legislature like Roger Marks, a retired state oil economist, are telling senators that to be competitive against tax regimes in most other oil-producing regions, who are Alaska’s competition for investment, the “total government take” on industry net profits needs to be reduced from the current approximate 74 percent at today’s oil prices to between 62 percent and 65 percent.
Government take includes all payments to the state, production tax, state property and the special corporate income tax on oil, and state royalty, as well as federal taxes. Within government take, the state’s share is much greater than the federal share.
Legislators are also examining a wide range of other ways of benchmarking Alaska against other producing regions, like Net Present Value of oil investments and Internal Rate of Return, but the total government take seems the most reliable apples-to-apples way of comparing fiscal regimes, Marks told the Senate Finance Committee.
There are several ways of getting to that 62 percent to 65 percent, however, involving combinations of various parts of the tax law, and this is what senators are now wrestling with.
However, what complicates matters is that it is important to the industry that the tax effect — the government take — be relatively even across a broad range of possible oil prices, high as wells as low. That’s because the companies judge their investments against several possible prices, and even “stress test” investments against a lower price to ensure a proposed project can break even or even make a little money if the oil price drops.
Each company’s “stress price” is different, and also confidential, but from comments several companies have made to legislative committees, the price range of concern is from $95 per barrel to $90 per barrel.
A key problem with the current ACES tax is that it ratchets up taxes at higher prices, including the current price, so that as much as 80 cents of every $1 in added revenue from a price rise goes to the state, the opposite has occurred at lower prices in the bills now before the Legislature.
The governor’s bill actually increases rates at lower levels, at about $90 per barrel, even while it eliminates the tax spike at higher levels. What the companies want is for the tax effect to be more level at all price ranges.
Smoothing the tax rate
The Senate Resources Committee, chaired by Sen. Cathy Giessel, R-Anchorage, addressed this problem in its substitute version for the governor’s bill, which is now before the Finance committee, by making a number of changes that in combination attempted to level the tax effect at lower prices while retaining the more level tax effect at higher prices.
The changes included increasing the base tax rate from 25 percent of net profits to 35 percent and allowing a $5-per-barrel tax credit on production. The Resources committee also made changes in the governor’s proposed Gross Revenue Exclusion for new oil, attempting to make it more workable for new oil developed in the large producing fields.
However, the companies say the new version of the tax doesn’t solve the problem of higher taxes at lower oil prices. The Senate Finance committee, which now has the bill, is wrestling with how to assemble the various elements of the tax to level it out.
The changes in the Gross Revenue Exclusion, intended to spur new oil, don’t really make it workable for new oil in existing fields either, the companies are saying. Work is still under way to solve this problem.
There are several tools senators can work with in the existing ACES law, as well as new ideas put forth in the legislation pending.
There is the 25 percent base tax rate in the present tax law, proposed to increase to 35 percent in the proposed new version of the Senate bill; the “progressivity formula” in the current law that ratchets up the tax rate as oil prices rise; a capital investment tax credit now in the law; and new ideas being put forth in the legislation like a “Gross Revenue Exclusion”, an allowance for tax relief on a certain amount of new oil produced.
In the bill before the Senate Finance Committee, there is the substitution of the 20 percent capital investment tax credit with a flat $5-per-barrel tax credit on all oil. Gov. Sean Parnell had proposed to eliminate the capital investment tax credit in his proposal introduced in January, but the Senate Resources Committee proposed to retain the concept of a tax credit with the $5-per-barrel credit.
Parnell also proposed eliminating the progressivity formula in his original bill.
Several senators, among them Sen. Anna Fairclough, R-Eagle River, favor retaining some element of it, but in a far milder form, as a way for the state to increase its share of any windfall profits if oil prices rise.
The progressivity formula is one of the key problems in the current oil tax because of the steep escalation rate in the formula, hiking the tax for every dollar of increase in the net value of the oil. With North Slope oil prices now as about $110 per barrel, it is the formula that mostly accounts for the 74 percent total government take.
If progressivity is retained it is likely to have a milder escalation rate and may also be “bracketed” so that the tax increase applies only to the increments of production at certain price intervals, similar to the way the federal income tax works, rather than having the tax increase apply to all the oil production.
Senators are now trying to figure out how to combine all of these elements, the tax rates, an option for a progressivity formula, the investment credits or a per-barrel tax credit, and the Gross Revenue Exclusion (the special incentive for new oil) in a way that levels the tax effect and also doesn’t discriminate against smaller companies while favoring larger companies.
Independent companies operating on the Slope have warned legislators that elimination of the investment tax credit does that.
Todd Abbott, president of Pioneer Natural Resources, which operates the small Oooguruk field on the Slope, said the capital investment tax credit in the current law will be important in helping Pioneer overcome the high capital cost of its planned Nuna oil project now being evaluated. Nuna is a separate oil deposit near the Oooguruk field that Pioneer hopes to develop, and is estimated to cost about $1 billion.
“The current proposal (the Senate Resources bill) is actually the worst for new entrants to the Slope,” Abbott told the Senate Finance Committee.
That’s mainly because the loss of the capital investment tax credit, “drives up the amount of capital (smaller) companies like Pioneer must raise to develop projects, which in turn reduces the value of the project,” Abbott said.
Large companies aren’t as affected by the loss of the capital investment tax credit because they have deeper financial resources, so the effect would be to encourage smaller companies to sell their projects to larger companies, Abbott said.
However, even larger companies have mixed views about the proposed changes. ConocoPhillips, a major North Slope producer, agreed with Abbott that there are advantages to the capital investment tax credit over the per-barrel tax credit, even though the benefits of the per-barrel credit can be much larger, and also continuing, once production begins.
Scott Jepsen, ConocoPhillips’ Alaska vice president for external affairs, said, “At the end of the day the tax credits give you the bigger bang for the buck,” over the other proposed incentives, because a company gets to use the money immediately and given the time-value of money this drives up the Net Present Value of projects.
At the start of the hearings last week the bias of the Senate Finance Committee seemed against the capital investment credits, however.
“We all have a bad taste in our mouths over the capital credits. They are costing us a lot of money, about $900 million next year,” said committee co-chair Sen. Kevin Meyer, R-Anchorage.
He asked Jepsen his opinion of capital tax credits compared with the proposed 30 percent Gross Revenue Exclusion, intended to spur new oil.
Jepsen stuck to his view, however. The Gross Revenue Exclusion, or GRE, designed to encourage new oil, does increase a company’s cash flow over a long period, “and long-term cash flow is important,” he said.
However, he still felt the capital investment tax credit is more helpful.
“One percent of capital investment tax credit is worth 4 percent of the GRE,” Jepsen told the Senate Finance Committee.
As they try to move all of these levers, an underlying concern of many senators is the cost of the tax changes in foregone revenues. Sen. Lyman Hoffman, D-Bethel, a member of the Finance committee, is very worried about this given the projected decline in state revenues over the next few years.
“We’ll be reducing our revenues by several billion dollars over the next five years,” Hoffman said.
Hoffman cautioned industry officials appearing before the committee to be mindful of expectations among Alaskans than if taxes are reduced, new investments will be made and the production decline halted. If that doesn’t happen within five or six years, the public may demand a restoration of the current ACES regime, Hoffman warned.
Tim Bradner can be reached at firstname.lastname@example.org.