Repealing oil tax reform will produce wide consequences

hoto/Courtesy/Office of Gov. Sean Parnell

If Alaska voters repeal Senate Bill 21 on Aug. 19, what will happen?

Under the state constitution, a law that is repealed goes off the books 30 days after the election results are certified by the lieutenant governor.

That means the previous oil tax, known as ACES, would be back on the books in late September.

In terms of sheer tax headaches, that will be a nightmare for the Department of Revenue and the tax administrators of companies that pay taxes and explorers who file for tax credit payments. Because ACES required monthly tax returns, oil producers would immediately have to file a tax return for October, oil company officials say.

However, would it be the end of the oil boom we’re now seeing?

Not immediately, the companies say. But if drilling slows again like it did in 2007, when the Legislature passed the ACES tax, the consequences for the state budget and the economy are sobering.

It would also not be good news for the large North Slope gas pipeline and liquefied natural gas export project. Senate Bill 138, which passed the Legislature this year to authorize state participation in the gas pipeline, also changed key parts of the state oil and gas production tax.

Impact on gas pipeline

If SB 21 is repealed, sections of the gas pipeline authorization bill will also be affected. It will take time to analyze that and it will definitely require changes to the tax statute by the Legislature.

Lawmakers would have to quickly pass a bill solving the problems. Given that a new Legislature in 2015 will have at least some brand new members, quick action is problematic if not doubtful. This could become a major issue in advancing the gas project.

Repealing SB 21 will also undercut the gas pipeline in other, more fundamental ways, company and state officials say.

The North Slope oil producing business needs to be economically strong to support commercial gas production. That’s because oil and gas are mostly produced out of the same wells and depend on the same North Slope infrastructure.

Oil pays for the maintenance of that infrastructure, however, because there simply won’t be enough of a profit margin in the gas to do that. Because production is expected to last for decades (the financing of the gas pipeline depends on that) SB 21’s repeal will endanger the oil business that economically supports gas.

That will undermine the economic structure of the gas pipeline. That project faces enough other hurdles like competitors and high costs, and this additional one could be a body blow to the project.

Gas revenues simply can’t maintain all the aging North Slope infrastructure.

As to how the repeal would immediately affect the gas pipeline effort now underway, the impact on the companies’ and the state’s efforts to market gas to Asia, which is getting underway this year, could be substantial.

The gas marketing teams will be seeking buyers for a 20-year to 30-year supply of gas and asking customers to sign “take-or-pay” contracts for those periods. With the economics of the enterprise, and the price of the LNG, thrown into question, the marketing efforts could be severely compromised.

Dan Fauske, CEO of the Alaska Gasline Development Corp., said there is a strong linkage between continued oil production and the gas project.

“The industry has consistently stated that a stable and predictable fiscal regime is central to making the long-term transportation commitments necessary to finance the construction of a North Slope gas pipeline. To the extent that a repeal of SB 21 puts Alaska’s oil tax structure back into question, I believe it will also alter the economics of the gasline, creating the real potential for delaying our progress,” Fauske said, adding that these were his personal opinions.

The consequences for the state budget are equally severe. North Slope oil producers have now stopped the decline in oil production, at least for this year. For years the decline rate was about 6 percent. In fiscal year 2013 it was 8 percent.

Budget scenarios

If the historical 6 percent decline rate were to resume, the state’s billion-dollar-plus annual deficits would continue unless there were immediate and severe budget cuts.

Under that scenario, the state will drain its existing cash reserves except for the Permanent Fund by 2020, Dr. Scott Goldsmith, senior economist at the University of Alaska’s Institute of Social and Economic Research, has calculated.

ISER publishes an annual report on the state fiscal gap, usually in December, authored by Goldsmith. Previous reports have estimated that state cash reserves will be exhausted by 2024 given the historic 6 percent decline and only very modest budget growth of 2 percent per year in state funds.

Last spring, the Legislature transferred $3 billion from state cash reserves to the public employees’ pension funds, which means the financial cushion is less by that amount.

The effect is to accelerate the exhaustion of reserves by four years to 2020, Goldsmith has calculated.

If that were to occur, the state Legislature would have to take drastic action in cutting budgets and tapping Permanent Fund income to help pay for the budget (unlike the principle of the Permanent Fund, the Fund’s income can be appropriated by the Legislature).

Taxes on citizens, like a state income tax and/or sales tax, may also be needed. With Permanent Fund income used to pay for public services, the citizen dividend would be sharply reduced or ended.

Goldsmith has made calculations for more positive scenarios, however.

Budget deficits would remain if the production decline were just halted, but if production were increased by only 1 percent per year, the deficit would be eliminated by 2023, although state cash reserves would still be emptied.

If production were increased by 2 percent or 3 percent per year, a healthy cash reserve, about $7 billion, would remain in 2023.

These estimates still assume a modest budget growth of 2 percent yearly, which may be challenging given normal population growth and inflation, Goldsmith has said.

Two other immediate consequences of a repeal are that a special exploration tax credits for exploring in “Middle Earth,” the large unexplored sedimentary basins of Interior and rural Alaska, will be gone. Those were a part of SB 21.

Doyon Ltd. in Interior Alaska, Ahtna Inc. in the Copper River region, and NANA Regional Corp. in northwest Alaska, are all planning exploration in their regions aimed at securing local sources of energy. The repeal of the new tax will likely end those efforts, the corporations have said.

Secondly, a special tax credit to help oil service companies relocate or build new facilities and equipment in Alaska will be gone. Under SB 21 service companies can take a credit for up to 10 percent of investments in Alaska facilities against their corporate income tax.

Will SB 21’s repeal endanger the renaissance in oil now underway on the slope? It probably will.

The oil companies themselves are reluctant to predict what will happen if the old tax law, ACES, comes back into effect.

The new drill rigs hired in the last year won’t immediately shut down, and some new projects announced will likely continue but on a more drawn-out schedule, the companies say.

But the bloom will definitely be off the boom, and the decline in production will likely return.

07/10/2014 - 9:39am