Senate works on oil taxes, but clock may run out

The state Senate is continuing its detailed review of state oil and gas taxes, but there are growing worries the clock will run out before any revision of the oil tax can be agreed upon.

Lawmakers must adjourn April 15, although there are procedures where the session can be extended.

The Senate Finance Committee was expected to have its version of the tax change bill, Senate Bill 192, finished the week of March 26. It is possible that the full Senate could vote on the bill and send it to the House in early April.

That leaves about two weeks for the House to consider a complex tax bill that will be different than House Bill 110, which the House approved last year and is now lodged in the Senate.

The House-passed bill was originally introduced by Gov. Sean Parnell and is supported by oil and gas companies as making enough changes to stimulate major new investment in the aging North Slope fields.

Oil production is now declining at rates of 6 percent or more annually and oil producers and the governor blame the state’s high tax rate as discouraging new investment.

In a presentation to the Senate Finance Committee March 21, ConocoPhillips officials said their company’s Alaska capital investments have been flat over the last three years while capital investments in the Lower 48 states have tripled.

“With oil prices as high as they are, we ought to be doing a lot more,” Scott Jepsen, ConocoPhillips’ external affairs vice president, told the committee.

The problem is the Alaska tax, he said. The company’s Alaska managers can’t get the money because investments in Lower 48 states are more rewarding.

Jepsen also told the committee that new investment by the industry would create more revenue for the state. ConocoPhillips’ analyses has shown that every $1 in new investment, the industry has generated $2 in new state tax and royalty income, he said.

“Every project is different but over the long run we believe the 2-to-1 ratio has been very consistent,” Jepsen said.

It takes time, however, for new projects to be brought on line, and Jepsen said ConocoPhillips is willing to work with legislators to find ways to ease short-term revenue reductions.

Another point brought out in the hearings, this one by the Legislature’s own consultants on the tax bill, PFC Energy, is that the current Alaska’s Clear and Equitable Share is clearly discouraging development of new oil production.

“ACES appears to work well as a ‘harvest’ (tax) regime. Existing mature fields remain profitable, including capital (investment) needed to achieve a 6 percent decline rate,” Janak Mayer, PFC’s upstream manager, told the Senate Finance Committee March 22.

The tax works well for the state, in a harvest mode, in that maximum revenues are extracted from the declining production base, Mayer said. But ACES is not a tax that encourages growth.

“ACES inhibits the development of new projects and resources that might help stem or even reverse the decline,” of production, he said.

While the state’s net-profits tax was originally intended, when first adopted in 2006, to be “progressive” to help high-cost and technically-challenged oil projects, the effect is actually the reverse, Mayer said.

“The high government ‘take’ (in ACES) applies even to very high-cost projects,” and has a detrimental effect on the break-even point at which high-cost projects can be developed, he said.

Also, the existing system of capital investment tax credits in the current tax law does not encourage spending on new production but instead encourages the major producing companies to spend money on “renewal” or major maintenance and replacement of production infrastructure, Mayer told the committee.

Sen. Lesil McGuire, R-Anchorage, expressed concern in the March 22 hearing as to how the capital tax credits are being used.

“I voted for these credits on the understanding that they were for new development. Now I am learning that they are actually being used for renewal,” McGuire said.

The credits are the 20 percent investment tax credit the state allows for all oil and gas capital investment. The original intent was that the credits would encourage producers to reinvest profits from Alaska production in the state.

Declines and deficits?

Meanwhile, the urgency for changing the state tax was highlighted by Damian Bilbao, BP’s head of Alaska finance and developments, when he spoke to the Senate committee March 21. Bilbao pointed out potentially huge deficits in the state budget that could appear if oil production continues to decline at the current 6 percent yearly, and with the state budget continuing to grow.

Bilbao showed the committee a chart, using state data, that showed by 2020 oil production would bring in only half enough revenue to fund the state budget. The assumption in the chart, from the state Office of Management and Budget, was for the budget to grow at 4 percent per year. In reality, the budget has been growing at higher rates. It is also likely that the decline in oil production will exceed 6 percent this year and next, industry officials have warned previously.

Bilbao said the quickest way to stimulate new production is to stimulate new “in-fill” drilling within the existing fields. The new revenues from added production, which could occur fairly quickly, would help offset any reduction in state income due to a tax reduction.

The tax reduction should apply to all production, however, not just new oil produced by the companies, because the base production from the mature, large fields is becoming more challenged by rising costs. Using data given the state revenue department by industry, Bilbao showed overall North Slope per-barrel production costs rising from just under $20 per barrel in 2010 to more than $25 per barrel in 2013.

He also expressed concern that PFC Energy, in its modeling work on the economics of a large North Slope producing field, was assuming a “lifting” or production cost of $12 per barrel, about half of what the actual costs are.

Finance co-chair Sen. Bert Stedman, R-Sitka, asked Bilbao to work with PFC Energy to do any needed updates to the consulting firm’s modeling. Bilbao said he would do that.

The most extended discussion of new oil possibilities came when ConocoPhillips’ Vice President of Finance Bob Heinrich and ConocoPhillips’ Jepsen came before the committee.

Jepsen agreed with Bilbao that additional drilling could add new production in mature fields like Kuparuk, which ConocoPhillips operates, “but (under the current tax) when we look at the long-term cash flow and the added investment we just don’t see the upside. We do provide capital to sustain the base production but it’s difficult to get approval to put on another rig or two,” to increase production, he said.

Jepsen also said he disagrees with the way the “harvest” term is being used in the discussions.

“There are fields in ‘harvest’ mode but these are fields where we see no upside,” or possibility of increased production. “But we are not in harvest mode here, because there are opportunities to grow. If ACES is changed it will change the game,” Jepsen said.

Senators were interested in whether ConocoPhillips thinks the Kuparuk field production could be increased above its current 140,000 barrels per day, or even if production could be increased back to 250,000 barrels a day.

It would be a challenge, Jepsen said. “We are essentially developing ‘new’ fields inside Kuparuk. These are (small) pools that are only available now because of improvements in technology,” he said.

There is a lot of potential with the large West Sak viscous oil resource in the Kuparuk field, but also major technical challenges.

“We have about 15,000 barrels a day of viscous production from the core care (of the West Sak) and we may be able to move to the next area of West Sak, but after that it gets really difficult. I can tell you some things we can do to offset decline, and with skill and science maybe we could see some increases,” Jepsen said.

The governor’s 1 million barrels-a-day production goal is ambitious, but it’s a good objective.

“Even it we achieve part of it we’d be very happy,” he said.

To actually achieve it would take moving forward on all fronts, with conventional, viscous, heavy and shale oil.

Oil from the offshore will also be important, because while this oil isn’t subject to state taxes it will contribute to state revenues because the larger volume of oil in the trans-Alaska oil pipeline will lower the transportation cost of oil from state-owned lands. 

Jepsen urged the Senate committee to be careful in adopting a tax reduction for new oil only.

“Keep it simple. If you try to parcel it out, you won’t get there. If you only give incentives to what you produce over the decline curve, you won’t get there,” in achieving new production, he said.

“We understand the (short-term) impacts to the treasury,” from a reduced tax. “Maybe there’s some way we can work through this. We won’t see an immediate near-term impact but in the long term there will be a positive impact. It may take five to seven years to get new production on line.”

The idea of applying a tax reduction to the entire production is meeting some resistance in the Senate committee, however.

“It will just move too much cash across the table,” Stedman said. “This leads us to a more complex discussion, the two-tiered approach. We hear you when you say ‘one size fits all’ but we have to be cautious. There is concern about our making it more complex. It’s complex enough.”

As the Senate committee develops its bill the major elements are known: There is agreement that some downward adjustment to the “progressivity” formula in the state production tax is needed. The question is how much the adjustment will be.

A minor change in the formula in SB 192 as it emerged from the Senate Resources Committee is considered insufficient to encourage new investment, PFC Energy, the consultants to the Legislature, have told the Senate Finance Committee.

Stedman and other members of the committee are very interested in some mechanism that will encourage development of “new” oil through a reduced tax, but also leaving taxes on existing production from older fields without a change.

A mechanism fordoing this proposed in the Senate Resources version of SB 192, by raising the “trigger price” at which the progressivity formula kicks in, was judged ineffective by PFC Energy. The Finance committee is now working on alternative ways of accomplishing this.

Updated: 
11/07/2016 - 4:16pm