“We will go back and look at every decision. This will impact our business plan for 2008,” said Claire Fitzpatrick, BP's commercial manager, in hearings in the last days of a special session of the Legislature called to consider the tax.

Fitzpatrick said the companies aren't about to fold up and close shop, though.

“This (the tax) is not an on-and-off switch. There are a lot of things we have to do and a lot of things we will still want to do.”

Still, it will affect investments at a time when the industry and the state are worried about declining production from the aging North Slope fields.

Kevin Mitchell, ConocoPhillips' vice president for finance and planning, told lawmakers, “This is a major tax increase. It will have an effect on investment.”

How much the companies actually pay will depend on the price of crude oil through the rest of the state fiscal year, which ends June 30, 2008. Legislators made the tax change retroactive to the start of the state fiscal year, July 1, 2007.

The lower estimate of $1.6 billion assumes an average price of $73.61 per barrel for the year. Oil prices have actually been above that for an extended period, however, and there will be lot more money flowing into the treasury if higher oil prices remain into 2008.

The surge of new revenue means there will be a big surplus in the treasury when the Legislative convenes in Juneau on Jan. 15. Gov. Sarah Palin has asked the public for ideas on how to spend the money. Palin on Dec. 15 releases her spending plan for fiscal 2009, which starts July 1, 2008.

Taxing oil

Palin on Oct. 18 convened the special session that produced the tax increase, saying the Legislature's enactment of the new Petroleum Profits Tax, or PPT, in 2006 had been clouded by corruption and that lawmakers should re-vote the tax law to restore public confidence.

The governor went beyond asking merely for a re-vote, however. She proposed changes in the tax, increasing the tax rate but also modifying the progressivity formula, which raised the tax rate as oil prices, and profits, rise. The state Department of Revenue also proposed a series of technical changes.

The Legislature changed the governor's bill after it was introduced. The end result was a 25 percent tax rate the governor had asked for, but a much more aggressive progressivity formula. The tax law that emerged from the Legislature at the end of the special session Nov. 16 resulted in tax increases on the industry that were twice as much as the governor's bill would have imposed. Palin did not object to the Legislature's changes.

The production tax is just one of several taxes paid to the state by the industry, however. The state also levies a special corporate income tax in oil producing corporations that is different than corporate income taxes on non-oil corporations.

The state also has a property tax on petroleum production and transportation (pipeline) property, which is the only state property tax.

The total state share of production net revenues also includes the royalty, which is 12.5 percent of the gross production revenues at the field level.

With the taxes paid to the federal government added, the total government share of production net revenues from North Slope production is estimated to now exceed 70 percent.

This is in the same range of government take as Norway and the United Kingdom, which impose some of the highest taxes in the world on oil production.

Total government share of industry net revenues is much lower in the Lower 48 and the Gulf of Mexico, approximately 30 percent to 40 percent. Companies exploring in Alaska, particularly the smaller independents, point out that in the competition for exploration investment, Alaska is really competing against prospects in the Lower 48, not Norway and the U.S., so the higher tax burden in Alaska puts the state at a disadvantage, they say.

Taxes are also affected by the state's policies in what cost deductions are allowed. Companies complain that there are numerous sections in the new tax law that make it uncertain what deductions are allowed.

Tom Williams, a BP tax attorney, singled out DOR's ability to define “allowable lease expenditure” deductions through regulations. “The problem for us is we won't know what's allowed, and there are huge penalties” if the company underpays, he said.

Bernard Hajny, a BP tax manager, said the “hidden taxes” scattered through the bills could add “tens of millions” of taxes to producers' tax bills, perhaps $100 million or more.

Kevin Mitchell, ConocoPhillips' vice president for finance and planning, points out that a denial of 5 percent of costs by state auditors is the equivalent of a 1 percent increase in the overall tax rate.

Mitchell said the underpayment penalties are severe. A 10 percent underpayment of estimated tax triggers a 10 percent penalty of the amount that was underpaid. A 20 percent underpayment triggers a 20 percent penalty of the amount underpaid.

Given the lack of regulations defining allowable cost deductions inadvertent underpayments are more likely.

No floor on old fields

Legislators did change one provision the governor had originally asked for. A proposal for a 10 percent gross revenues tax to be imposed on the two large producing fields - the Prudhoe Bay and Kuparuk River fields - as a kind of minimum tax “floor” was removed.

The administration had proposed this as an alternative tax for the Prudhoe and Kuparuk field to protect the state if oil prices drop (the gross revenues tax is less sensitive to price changes than a net profits tax). The producing companies would have calculated the tax both ways and paid which ever showed the higher tax.

Legislators were concerned about the impact the gross tax would have on the development of high-cost heavy oil deposits in the Prudhoe and Kuparuk fields, and removed the provision from the bill. However, the final version of the tax bill does impair heavy oil development because of limitations on the operating costs the companies can deduct, through the so-called “standard deduction” provision of the tax bill.

State revenue Commissioner Pat Galvin told lawmakers the governor didn't object to removing the gross revenues tax if the tax rate was increased to bring in more money at high oil prices through the progressivity formula, and lawmakers agreed to save that money in a fund to tide the state over if there were an oil price drop.

Legislators did change the tax so that it brought in more money at high prices but there was little discussion on saving the extra money.

In the end, legislators included the standard-deduction provision that limits operating cost deductions in the two largest fields to 2006 levels, which causes the tax to behave more like a gross revenues tax without cost deductions.

Democrats in the state House pushed this provision through because they were worried that the producing companies might “game” the state by inflating operating cost deductions to reduce their tax payments.

This “standard deduction,” as it came to be known, allows 3 percent annual growth of the tax from 2006 levels, but this is far below the actual escalation of oilfield costs the companies are experiencing.

Because of this, the effectiveness of the net revenues tax in the two largest fields is essentially negated since deductions of actual costs are not allowed.

BP and ConocoPhillips, the two operating companies at Prudhoe and Kuparuk, have also pointed out that by limiting the deduction of operating costs, the state will also impair the development of high-cost heavy oil projects on the North Slope, which are mostly in the two large fields.

As these projects are brought into production the operating costs increase, more so with heavy oil than conventional crude oil because of the thickness and cold temperature of the oil, which require special handling.

Because the additional costs cannot be deducted against the state tax the effect, indirectly, is to increase the state tax on heavy oil. This could limit heavy oil production because the economics are marginal to begin with. By not allowing all the costs to be deducted, producers pay the same tax rate on heavy oil as it does on conventional oil.

That is contrary to the original intent of the net revenues tax, which is to allow costs to be deducted as an encouragement to high-cost projects like heavy oil.

Another provision in the tax bill reduces the effect of a state tax credit program intended to spur new exploration by decreasing the period private data given the state is held confidential.

The exploration tax credit program requires companies receiving tax credits to give the state information they get from drilling and seismic work, data that is highly valuable to the companies and also the state, which can use it to evaluate undeveloped state lands.

The new law reduced the confidentiality period for exploration data transferred to the state from 10 years to two years under the exploration tax credit program. This essentially negates the incentive, ConocoPhillips' Mitchell told legislators.

Data gathered by explorers at great expense will go public, and to competitors, before the explorers can get any benefit from it because two years is not enough time to plan and execute new exploration or development work based on the data.

Others in industry told legislators that a change in the law that requires explorers to get state approval for the exploration credits introduces more uncertainty. Because the companies will never be sure they will get the credit until after they invest the money and do the work, the companies will not include the credits in modeling the exploration prospects. This negates the benefit of the tax credits in attracting explorers.