The oil tax referendum: Competition matters

At current prices and costs it appears that ACES and SB 21 would bring in about the same amount of revenue now. Where they differ is what happens at higher prices.

ACES was enacted in 2007. The progressivity structure imposed very high taxes at high prices. It eliminated nearly all upside potential: the ability for producers to make somewhat proportionally more money when oil prices are high.

For instance, if oil prices were to get to $140 per barrel again, the marginal tax rate under ACES would be about 90 percent. That means every time the price goes up $1, the government would get 90 cents of that dollar. 

Upside potential is important in shaping investment decisions, in large part because it offsets low price risk. When investors evaluate opportunities they incorporate future oil prices. There is much uncertainty about prices so they evaluate projects over a range of outcomes. Economic feasibility depends on upside potential being able to offset downside price risk. So what happens on the upside can have a big impact on results.

Even if upside potential is of relatively low probability, so much money can be made when it does happen that it can make a project worth developing. But if upside potential is suppressed, like it was under ACES, it may not be worthwhile to develop the project.

A fundamental principle of oil development is that oil does not produce itself. Be it old or new oil, it needs capital. The capital comes from the debt and equity of the corporations. These investors have lots of opportunities; their capital is fluid, but finite, and it goes to where it gets the best deal. Jurisdictions have to compete for it.

Alaska competes with other jurisdictions with similar risk/reward profiles in regards to reserves, cost, risk, and operating conditions. These would include other North America jurisdictions, Arctic jurisdictions, other tax and royalty regimes, and places with similar production/reserves. The average government take (total taxes and royalties going to state and federal governments as a percentage of pre-tax profit) in these places is about 60 percent.

Under ACES at a $140 per barrel oil price, the government take would be about 73 percent. That 13 percentage-point difference would be worth about $1.8 billion per year. Investors could demonstrably make more money in nearly any other place than Alaska with similar development conditions.

Why would they want to do business here? Even if it was profitable, it was more profitable elsewhere.

In 2007, there was upwards of $60 billion in infrastructure from past investments on the North Slope that had nowhere to go. It was “captive” investment. This infrastructure was put in place to produce oil over an extended number of years, including the present and the future.

So, after 2007, production from that past investment continued, paying higher taxes. The state made lots of money, and some of that money no doubt did good things, but it came at a price.

Since 2007, oil prices have gone from a $60 per barrel world to a $120 one. Investment should have soared. Worldwide, between 2007 and 2012 upstream capital outlays for exploration, development, and production increased 60 percent adjusted for inflation. Here, instead, it increased only 16 percent.

As a result, in 2013 the outlook for production under ACES was only 300,000 barrels per day in 10 years, and 200,000 in 15 years. Yet the additional oil is clearly there.

Where the state constitution calls for resources to be used for the maximum benefit of its people, that must mean future generations, as well.

The tax rates under SB 21 are more in line with the competition. If producers can earn here what they earn in other places, they should invest here like they invest in other places.

Production will likely increase relative to ACES. While it is impossible to say exactly how much more, even at higher prices it would only take a modest amount of additional production over the ACES forecast for SB 21 to bring in more total petroleum revenue (including royalties, property taxes, and state corporate income taxes).

In the early 1960s when the state was deciding how to develop its land, it could have started its own state-owned oil company. Rather, it chose to open up its resources to the world through the competitive bidding lease system.

The experience, expertise, and capital of multinational corporations was brought here to explore and develop. The lessees made the monetary outlays and incurred the geological risk. Development proceeded from market forces.

Fair share is what you can get in a competitive environment.

Roger Marks is a petroleum economist based in Anchorage.

11/21/2016 - 4:44pm