How SB 21 attempts to solve the problems with ACES

AP Photo/Bill Roth/Alaska Dispatch News

Senate Bill 21, passed by the Legislature in 2013, aimed to solve the problems that had appeared in the previous oil production tax, known as ACES.

The bill, effective as of this past Jan. 1, has sparked raging debates over the financial effects of the tax change — whether or not it was a tax “giveaway” to the industry — but there are two new provisions in SB 21 that have received little attention.

One is a “frontier basin” incentive that encourages drilling in the huge, unexplored sedimentary basins of Interior and Western Alaska, where discoveries, most likely natural gas, could supply local sources of energy.

This provision essentially extends to rural areas a set of exploration tax credits and stable tax rates that have applied in Cook Inlet for years. When Southcentral Alaska utilities became worried about depleted gas reserves in Cook Inlet gas fields a few years ago, the Legislature quickly pushed through incentives to get new drilling underway.

It worked.

Companies have been exploring for, and finding, new gas supplies since then. The worry over shortages is over, at least for the time being with utility supply contracts secured through the 2017-18 winter.

Now rural Alaska wants to do the same thing to bring relief from sky-high energy costs. Interior Alaska Native Regional corporation Doyon Ltd. is now exploring the Nenana Basin west of Fairbanks and the Yukon Flats Basin north of the Interior City. (see story, page B8)

Doyon can afford to drill, and risk its own money, with the help of the incentives enacted in SB 21. Without them, Doyon would not have been able to do much exploration, according to Doyon CEO Aaron Schutt.

It’s a similar story in the Copper River basin near Glennallen. Ahtha Corp., Alaska Native regional corporation based there, hopes to find natural gas for local heating and power generation. The new incentives in SB 21 will help it attract industry partners, Ahtna has said.

Ditto for NANA Regional Corp., based in Kotzebue, which believes the Selawik Basin in that region could hold gas that could be a local source of energy.

Secondly, there is a tax credit for oil and gas service companies who relocate facilities from the Lower 48 to Alaska or build new or expand support facilities in the state.

Little Red Services, a locally-owned support company, is one company that has already taken advantage of this. The company has relocated a plant from North Dakota to Anchorage.

SB 21 allows a service company to credit up to 10 percent of its investment against Alaska corporate income taxes. The provision in intended to favor Alaska-based service companies according to Sen. Click Bishop, R-Fairbanks, who sponsored the amendment to SB 21.

Bishop believes helping local service companies and suppliers will boost Alaska-hire in the industry support sector.

Simpler, easier to understand

The most important change in the state’s petroleum tax brought by SB 21, however, is that the new tax is simpler and easier to predict, although its base tax rates are actually higher than the ACES tax.

Under SB 21, the base tax is 35 percent compared with a 25 percent under ACES. The new tax is simpler, however, mainly because the “progressivity” formula that was in ACES has been eliminated.

Eliminating the progressivity formula helps the state in important ways. The formula contained a tax escalator provision that raised the tax rate by 0.4 percent for every $1 per barrel gain in the value of oil. This had the effect of hiking tax rates quickly to high levels when oil prices climbed.

The problem this created for producing companies was that taxes could climb steeply and unexpectedly.

It was also unpredictable for the state, as it turned out. While the progressivity formula caused tax rates to climb sharply and quickly when oil values increased, the same thing happened in reverse when oil values dropped.

Precisely this happened last fiscal year. Oil prices dropped a bit, per-barrel producing costs rose (partly because production had also dropped) and the lower net value of the oil (revenues minus costs) caused state revenues to plummet.

It caught the Department of Revenue and state legislators off guard.

The state will run a $1.8 billion deficit in the fiscal year just ended June 30, requiring a draw from state cash reserves. Part of the blame for the deficit can be laid to ACES, which was in effect for the first six months of the fiscal year.

The new law, under SB 21, has no progressivity formula. Its base tax rate is 35 percent no matter what happens to oil values. 

While the base tax rates differ, the effective tax rate under SB 21 is softened by production tax credits that are allowed because under SB 21 there is a new per-barrel tax credit.

The same reduction in the effective rate happened under ACES, although the mechanism was different.

Under ACES a capital investment tax credit allowed companies to credit 20 percent of their capital expenditures, which also brought down the effective tax rate. The comparisons might differ from year to year due to changing costs and oil prices but for this year at least the financial effect of tax credits under ACES and under SB 21 would be about the same.

Incentive for new oil

A second key achievement of SB 21, in the view of its advocates, is that it contains a direct incentive for new oil development, which ACES did not have.

The “new oil” incentive is a tax credit of $5 per barrel for new barrels produced from a geologic reservoir that was previously not drilled. To qualify for these credits, the oil must be from non-producing deposits that are separate from existing fields, or clearly defined deposits within existing fields that are separate from reservoirs that are producing.

The Division of Oil and Gas, which has experienced petroleum geologists on staff, will help the Department of Revenue make the determinations of when “new oil” can be eligible for the tax credit.

There is a complicating factor with the per-barrel production tax credit, however.

The $5-per barrel tax credit for “new” oil is given to barrels produced from separate new deposits. However, a lot of new oil can be squeezed out of the older producing fields with new drilling and new technology.

Although the fields are older, history has shown that mature producing fields are the best place for companies to develop new oil.

In fact, most of the known but undeveloped oil resources of the North Slope are in the existing fields, state geologists have said. 

To provide an incentive to tap these resources, the Legislature granted a sliding scale, per-barrel tax credit in SB 21 that applies to all production from the field, without attempting to distinguish whether it is “new” or “old.”

The credit ranges from zero at high oil values to as much as $8 per barrel if oil values drop to lower levels.

Since these per-barrel tax credits would apply to all production from the existing fields, critics of SB 21 have criticized this as a major “giveaway” in the new tax law.

It was to counter the adverse financial effect of this, however, that the Legislature raised the bas tax rate in SB 21 to 35 percent from the 25 percent tax rate under ACES.

The financial effect to the state may be softened by the higher tax rate but the underlying structural change in SB 21 of tax credits linked to production rather than spending, as it was under ACES, was a primary goal for Gov. Sean Parnell and the Legislature in making the change. 

07/10/2014 - 10:21am