Last year, the department convinced the governor to make one administrative change affecting the ELF as it applied to satellite fields near the big Prudhoe Bay field on the North Slope. Under the formula, the satellites were paying little or no tax. By administrative order, the governor changed the way the ELF is administered, treating Prudhoe and the satellites as one big producing unit instead of several. This change resulted in production taxes being applied to the satellites and increasing state revenues by more than $200 million.

The Prudhoe Bay producers - BP, ConocoPhillips and Exxon Mobil - appealed the measure. The appeal is still unresolved, but chances are nil the governor will now change course.

A chance to just toss the whole ELF, however, came along when the same companies, negotiating a contract for a natural gas pipeline to the Lower 48 with the administration, asked that a "cap" on oil taxes as well as gas taxes be included in the deal. The governor said he would consider it, but he wanted the industry to accept a radical revision of the production tax in return.

That proposal will soon be before the state Legislature in the form of a new net-profits-based production tax. Democratic legislators have already filed a version of oil tax revision legislation.

But why is the administration so unhappy with the current tax and its ELF formula? Mainly because it has become dysfunctional, both because of the way the industry has developed, and the way it works when oil prices are high, as they are today.

The state's nominal production tax rate is 15 percent of the netback value of crude oil on the North Slope. The netback value is determined by subtracting tanker and pipeline transportation costs from market sales prices. The ELF formula lowers the tax rate, however, for fields that are small or where wells produce low volumes. The intent was to help economically marginal projects; and it has done that. But it is also helping a lot of large and profitable projects, more than is justified, according to state Revenue Commissioner Bill Corbus.

Because of the ELF formula, this year the Kuparuk River field on the Slope, the second largest oil field in North America, will pay no production tax. "That is ridiculous," said Pedro van Meurs, a consultant to the revenue department.

Although the nominal rate of the production tax is 15 percent, the actual average rate paid on the slope is 7.5 percent for last state fiscal year, fiscal year 2005. It will be even lower in the current year. Corbus said that in a few years, very few barrels being produced from the North Slope will pay any production tax.

How did the ELF get to be so dysfunctional? Mainly because it was tinkered with over the years in attempts to solve particular problems, but each change created distortions years later.

The ELF was actually enacted in 1977 - the year oil production started on the North Slope - when the Legislature increased production taxes overall but at the same time wanted to protect Cook Inlet's smaller and maturing oil fields.

The Department of Revenue wanted to allow a reduction in tax for fields with higher costs, and the department's original proposal was for the producer to show the state its costs to justify the tax reduction.

For reasons few remember today, the Legislature took a different approach, instead using a minimum number of barrels of daily well production - 300 barrels per day, in fact - as a proxy for a well's economic threshold. If a well produced 300 barrels a day or less, it got a tax break. North Slope wells, in comparison, were then producing thousands of barrels of oil per day.

In 1989, however, the Legislature made other changes to the formula. It added field size as a criteria and changed the formula, adding an exponent. By then, the giant Prudhoe Bay field was declining in production and would have gotten a small tax break under the 1977 ELF formula, and the Legislature wanted to prevent Prudhoe from getting its break. The effect of the formula change was to not only keep Prudhoe's taxes at the maximum, but to substantially increase taxes on the Kuparuk field.

However, as time has passed, more and more wells are drilled even in the big fields, to the point that even very large fields with many wells would pay no tax, van Meurs has pointed out.

The ELF formula functioned well several years ago, when oil prices were in the $12 per barrel to $15 per barrel range. But it no longer works as intended.

Van Meurs presented examples to the legislators of a giant field producing 600,000 barrels per day with 2,000 wells producing 300 barrels per day each. Under the ELF this field would pay no production tax.

At the other end of the spectrum, a small field producing 30,000 barrels per day with just five prolific wells averaging 6,000 barrels per day would pay a substantial production tax.

Because of effects like this, "the ELF is no longer rational in relation to well productivity and field production," van Meurs told the legislators.