State works to formalize method for assessing oil and gas properties

  • Nabors drilling rigs sit idle at Prudhoe Bay in this May 25 photo. State regulators are working to finalize the method for assessing oil and gas properties for tax value that they have been using for the past several years. The new regulations apply to all oil and gas properties other than the Trans-Alaska Pipeline System. (Photo/Michael Dinneen/For the Journal)

Some of the affected parties are raising concerns as state tax assessors are finalizing a methodology for valuing oil and gas properties other than the Trans-Alaska Pipeline System for the first time.

Alaska Petroleum Property Assessor Jim Greeley said in an interview that the way the state currently assess values for oil and gas properties isn’t new; it’s been phased in over the last five years.

However, the means for assessing the industry’s often complex and extremely expensive infrastructure has never been spelled out in state regulations, according to Greeley.

“The regulation provides only high-level, broad guidance that basically says for production properties you have to use replacement cost (valuation),” he said. “Then for pipelines it says you can use sales, income or replacement cost and it stops there so there’s no specifics of methodology in currently. That’s what we’re trying to fix.”

The vagueness of the regulations opens the door to subjectivity by the state and local governments or the property owners, creating a situation that’s “ripe for appeal,” Greeley added.

That’s exactly why local governments and the producers fought over the value of TAPS for so many years, he said; there were no ground rules defining how it would be valued.

The Tax Division hopes codifying a specific methodology in regulation will add transparency to the assessing process and clarity to the results so everything is understood by all the involved parties, he continued.

The challenge in valuing oil and gas properties in the state — just another in the list of issues unique to Alaska — is that they don’t fit the mold of traditional business and residential properties, or even that of similar industry infrastructure elsewhere.

The property tax assessments most folks are familiar with are market-based but that doesn’t work for Slope oil pipelines or process facilities.

“When you have 50,000 homes in Anchorage you’ve got all sorts of comparables and you actually have an active market of buying and selling to conduct those assessments under that (market value) standard. We don’t have an active (oil and gas property) market where we have similarly situation properties to compare to. There’s only one Alpine; there’s only one Prudhoe Bay,” Greeley said. “Conversely, not only is there only one of them, they’re not being actively bought and sold so we don’t have that marketplace.”

In most Lower 48 oil and gas basins, pipelines, reservoirs and their associated facilities change hands frequently enough to apply the well-understood market value principles, he noted.

Father time has also complicated how the replacement cost of a property is calculated. When the laws outlining oil and gas property taxes were written roughly 40 years ago, replacement cost was pretty much what the facilities had just been built for. As things have aged and technology has changed, determining what it would cost to replace a facility has become largely theoretical, Greeley said.

To combat those problems, the Tax Division has gone to the “use-value” standard first employed by the Alaska Superior Court and eventually the Supreme Court in litigation over TAPS.

Greeley emphasized the regulations the division is considering are not for TAPS, which has a long history of value disputes.

‘Use-value’ standard

In February 2014, the Alaska Supreme Court upheld a 2011 Superior Court ruling that concluded the value of TAPS is primarily based on the proven reserves that will eventually flow through it. At the time, the Supreme Court set the taxable value of the iconic pipeline at $9.9 billion; the owner companies had sought an $800 million value.

In March 2016, the TAPS owners, who are the three major North Slope producers, the North Slope Borough, the City of Valdez, and the state settled on an $8 billion value through 2020 to at least temporarily stop the nearly endless litigation over the issue.

While not for TAPS, the valuation methodology the state uses does follow the principles laid out by the Alaska courts.

At its base, the use-value standard the state now employs on all unrefined oil and gas properties uses proven reserves — arrived at via production data — to determine the value of the facilities dedicated to exploiting those reserves.

Refineries are assessed at the municipal level.

“The reason we look at production is production is highly correlated to be the best measurement of what the proven reserves are,” Greeley said. “In other words, when Prudhoe Bay had 10 billion barrels of proven reserves it was producing at its plateau rate, 1.6 million barrels (per day); and when Prudhoe Bay had 2.5 billion barrels of reserves in 2009 it was producing 300,000 barrels per day.”

He continued to explain that production data from the prior year is entered into a regression formula and looking back one can see that a field’s reserves and production correlate nearly perfectly over time.

Reserves available to feed oil and gas facilities are a good measurement for valuing the facilities on a replacement cost basis because the infrastructure is almost always built to exploit a single reserve.

As the available oil and gas depletes and production declines, the size and capacity of the facilities needed to serve a given reservoir also declines — and so does the minimum cost to replace it with a facility capable of handling a smaller oil and gas pool. Therefore the facility’s value depreciates.

Greeley also said actual proven reserves data is very hard to get; companies generally keep detailed figures close to the vest and if it can be obtained it is confidential taxpayer information.

Thus, using it would be contrary to a primary tenant of property taxes: that the method to calculate them is transparent and taxable values can be compared against each other.

Production data is readily available to anyone on multiple state agency websites.

“When the field has produced all of its proven reserves and you look back at how we depreciated it you’ll have no possible other outcome other than to have perfectly depreciated it over the life of that field and that’s because we’re letting the reservoir tell us what depreciation should be over the life of that field,” Greeley said.

Oil price and other factors are accounted for through production, he added; if the economics of a field worsen the economically recoverable reserves will decline and that will ultimately show up in production figures.

Prior to phasing in this methodology several years ago, state oil and gas property assessors conducted deterministic production forecasts, which Greeley described as “radically error prone” because they had to predict what a reservoir would produce.

“When you look back at our depreciation applications it’s just the opposite. You have no other choice than to always be wrong. You need to be able to predict oil price; you need to be able to predict development; you need to be able to predict reservoir performance; you need to be able to predict all these things and then you have to come up with this deterministic estimate,” he said. “The probability of being perfectly correct is almost nil. By telling the reservoir what it’s going to do you’re just injecting a higher error rate into the assessment.”

Overall tax revenue has not changed significantly since the new use-value approach has been applied, but most importantly it has not led to a single taxpayer appeal, according to Greeley.

In 2016, the state collected $111.7 million in oil and gas property taxes, but much more went to municipalities, namely the North Slope and Kenai Peninsula boroughs.

While the state conducts oil and gas property tax assessments, local governments are able to apply their mill rates on the state’s assessments to collect their portion of oil and gas property taxes. Companies then use the local tax payments as credits against the state’s 20-mill oil and gas property tax rate.

In July, the Revenue Department held a workshop to explain the use-value approach and obtain feedback from taxpayers before formally proposing the regulatory changes.

Whether or not the department will ultimately move to add methodology to state regulations hasn’t been decided, Greeley said, but the process to do so will likely be started sometime yet this year if the Revenue Department moves in that direction. That process also includes further opportunities for stakeholder input.

The workshop elicited letters from the City of Valdez and three companies: BP, ConocoPhillips and small independent producer Caelus Energy.

Greeley characterized the comments from BP and ConocoPhillips as primarily clarification questions, saying conversations with officials from both companies about the methodology have been favorable. He again noted the approach has not led to any appeals since it has been put into practice.

Among other things, BP asked several questions regarding how equipment aging on the harsh North Slope is factored into the use-value approach and whether or not equipment that has been fully depreciated under the methodology still has an economic value even if it is idle and probably wont be used again.

ConocoPhillips Alaska officials stated that the definition for replacement cost — while seemingly straightforward in that it is the estimate to construct a new property to meet current needs — could lead to differing interpretations and “provides plenty of opportunity for dispute.”

They further noted that how the method is applied to facilities fed by multiple reservoirs was not addressed during the workshop and recommended the department share its plans on how potential issues arising from that will be resolved.

Caelus Energy Vice President Marc Byerly had more direct criticism for Revenue officials. He wrote that the methodology is “inconsistent with both the current tax law and current tax regulation.”

He contended that reproduction cost is being used instead of replacement cost, and that depreciation is not based on the economic life of proven reserves because reserves are not estimated in the calculation.

Further, he stated that the methodology does not account for physical deterioration of assets and “ignores” external obsolescence, or depreciation based on factors outside the property.

“We look forward to working with Caelus to deal with issues they’ve brought up and we hope the (proposed regulation) process will forward that opportunity,” Greeley said.

To Valdez, he said the comments from city’s attorneys were mostly concerns based on where they’ve been with TAPS. The Tax Division believes TAPS’ value and the corresponding taxes will continue to be arrived at via settlement, according to Greeley.

Local help

Separate from the methodology regulations, the Tax Division is looking for help conducting oil and gas property assessments from the local governments that are home to Alaska’s oil and gas industry.

It’s yet another consequence of the state’s continuing multibillion-dollar budget deficits.

“Everything’s cut; we’re resource constrained so the state is looking at the provisions in (law) which allow for municipalities to assist in the assessments under MOU (memorandums of understanding),” Greeley said. “We’re looking to see if there’s any interest from municipalities to participate with the state and assist under those existing statutory provisions.”

He said it’s something Tax Division and Revenue officials have been discussing with local leaders for a couple years.

Personnel has been cut from the overall Tax Division, but Greeley said he still has his tax technician and staff appraiser. Where he felt the hit was in his contract budget.

“I get real busy during the assessment season and historically we would spend significant amounts of money to bring in temporary assistance to get through the assessments in terms of contract staff and that has been completely wiped out. So, in other words when we need it most that assistance is no longer there,” he said.

He specified the cost to usually be a couple hundred thousand dollars, noting it varied year-to-year.

Valdez Mayor Ruth Knight signed an MOU, with the Revenue Department in late March to take on oil and gas property audit responsibilities inside the city under the department’s direction. That includes hiring contractors at the city’s expense, according to the MOU.

The North Slope Borough agreed to help the state through MOU in 2015 and while that agreement is not active, Greeley said it remains in place so the state and borough can collaborate when need be. The MOU notes the state retains sole authority to determine taxable property values.

Outgoing Kenai Peninsula Borough Mayor Mike Navarre, who has reached his term limit, decided against helping the state with assessments after conversations this summer because he couldn’t ask the Assembly for $25,000 the borough would get a tangible return on, according to Navarre’s Chief of Staff Larry Persily.

Persily said the mayor is certainly aware of the department’s budget situation and sympathizes with Revenue officials over it but he couldn’t see how the local government would get its money back. He also said the $25,000 figure was one floated by the department leaders in the summer meetings as the amount they hoped the borough would kick in to the state’s effort.

Persily did note, though, that the new borough mayor after the Oct. 3 election might be more amicable to the idea.

New Revenue Commissioner Sheldon Fisher, who took over for Randy Hoffbeck after he retired from the position in August, might also have different ideas about how the borough could help, he added.

Elwood Brehmer can be reached at [email protected].

09/25/2017 - 4:34pm