Friday, January 6, 2012

Battle on ACES tweaks to dominate session

Analysis by Tim Bradner
Alaska Journal of Commerce

The 2012 state legislative session convenes Jan. 17, and probably the most important bill on the session agenda besides the budget is Gov. Sean Parnell’s bill to reduce the state oil production tax as an incentive for new industry investment. It will be a very contentious issue and it may preoccupy legislators in terms of dealing with other significant matters, excepting the state capital budget.

There will be tough sledding for the governor on this bill as it was in 2011. Senate Democrats, who are partners in the Republican-Democratic Senate leadership coalition, appear to be dug into their positions opposing House Bill 110, the governor’s bill that passed the House last session.

However, there may be some room for optimism. In a December talk to Commonwealth North, an Anchorage-based public policy group, Senate President Gary Stevens, R-Kodiak, said the Senate Majority would examine the tax and particularly the “progessivity” formula, a formula in the tax that ratchets up the tax rate as oil prices climb.

Another key Senate leader, Sen. Bert Stedman, R-Sitka, said in legislative committee interim meetings this fall that he recognizes that state taxes on North Slope oil and gas operators merits a close look, and that a mismatch now exists between the industry’s economic situation in Cook Inlet, where there are virtually no state taxes, and the North Slope.

The action on HB 110, will take place mainly in the Senate. It passed the House last March by a vote of 22 to 16, a narrow margin because 21 votes are needed to pass a bill in the 40-member House. HB 110 is now in the Senate Labor and Commerce Committee, which held hearings last summer on employment aspects of the legislation with a focus on local-hire in the oil and gas industry. If the bill moves from the Labor and Commerce Committee it would go to the Senate Resources Committee and then to the Finance Committee.

HB 110 is important because it seeks to stimulate industry investment on the North Slope, hopefully stabilizing or reversing the decline in production. Critics argue the bill gives back too much to the industry and that there are no guarantees that new investments would actually be made. Last year the industry was not able to convince legislators, particularly in the Senate, that investments would occur if tax relief were given.

Near the end of the session ConocoPhillips’ CEO Jim Mulva came to Alaska and in a talk to an Anchorage business group, came as close as any senior executive can come in making a guarantee that a billion dollar-plus project in the west part of Prudhoe Bay would move forward if the tax were adjusted.

Guarantees like this are difficult for public companies because boards of directors ordinarily approve projects. Also, ConocoPhillips has partners in the Prudhoe field, which also must give approvals. In this case, BP’s Alaska president echoed Mulva’s commitment in a separate speech a few days later.

It was, however, too late in the session. Attitudes in the Legislature had already hardened.

The major producing companies, and the governor, argue that there is insufficient new investment on the North Slope in projects that will produce new oil, such as new production wells in the existing fields and projects to increase production of lower-quality oil, such as thick, or viscous, oil now being produced in limited quantities.

Substantial capital investments are being made in the North Slope oil fields, and these amounts are even increasing, according to state Department of Revenue data. But field operators say that much of this is focused on increased maintenance of aging facilities in the producing fields, and that money allocated for new production, such as new in-field drilling, is lagging.

ConocoPhillips, which operates the large Kuparuk field, has said that nearly 70 percent of its capital budget is now devoted to maintenance. A year ago the percentage devoted to maintenance was 60 percent. Given that the capital budgets of the two major operating companies, ConocoPhillips and BP, have been relatively static in recent years, about $900 million a year for each, this means less money is going to develop new oil in the producing fields.

New exploration no panacea

There is new exploration under way, but it is no panacea. The winter 2012 North Slope exploration drilling season looks to be the busiest in many years, but most of this is being driven by one company, Repsol, which has four to five rigs contracted.

Repsol has said it must develop an aggressive exploration program this winter because of expiration deadlines on some of the 500,000 acres of state leases in which it holds an interest. Absent Repsol, the winter exploration season looks about average, with three small independent companies planning test wells.

However, accumulations that might be discovered, at least on state-owned lands, are likely to be modest in size, even Repsol acknowledges. No large Prudhoe Bay-type finds are expected, in other words. Also, any discoveries will take several years to put into production because of the lead times needed to secure permits and build infrastructure like pads, wells, roads, utilities and pipelines.

In contrast, the governor and supporters of HB 110 argue that substantial additions of new oil could be put into production quickly enough to make a difference in slowing the production decline, but this must come from within the existing producing fields, where there is currently infrastructure.

In many cases the resources are known – the large deposits of viscous oil, for example – but the major producing companies say these projects are uneconomic to develop unless the existing state tax is changed.

The surge in exploration is also somewhat of an illusion in that the state itself is paying for much of the cost of the new wells, more than half in some cases, through exploration incentive tax credits in the production tax law. This has created an unusual situation of a tax subsidy for exploration of likely modest oil deposits but an overall tax law that discourages larger resources being developed in the larger fields, the supporters of HB 100 argue.

HB 110 changes the formula

The governor’s bill would address this by reducing the production tax rate and making other changes. The current tax is structured to increase the tax rate as crude oil prices rise to the point that, at the current range of oil prices, Alaska’s tax may be among the highest in the world. Given that the North Slope state-owned lands offer prospects of only modest discoveries and that access is costly, it can be seen why Lower 48 states are enjoying a surge of new industry investment and Alaska is not.

House Bill 110 reduces the tax by changing the “progressivity” formula in the law that causes the tax rate to escalate at high oil prices. The bill also “brackets” the tax law so that it works like the federal income tax, so that high tax rates apply only to the higher brackets of oil prices. The governor would also extend to the North Slope most of the investment tax credits and other incentives that now apply to Cook Inlet, where there is a resurgence of new industry exploration.

The argument against HB 110

The argument against HB 110 is mainly that the bill would result in a significant reduction in future state revenues – how much depends on the assumptions made – and there is no guarantee that new investment would follow.

With production declining, legislators are acutely aware of the fragility of the state’s future finances and are wary of giving up the certainty of revenues in the existing tax system without some clear guarantees that investments will be made that will result in new oil production, strengthening the fiscal outlook.

There seems to be wide political acceptance in the Legislature, even among opponents of HB 110, for the exploration investment tax credit approach, even to the point of the state paying for most of the cost of the new exploration. The difference between the two approaches is that HB 110 would cause a general reduction in taxes, while the investment tax credits, a different form of tax reduction, occur only after an investment is made.

This is an important point. For a long time the governor was lukewarm to the idea of a general tax reduction, like that now proposed as the core of HB 110, but supportive of tax reductions linked to performance, such as through an investment tax credit mechanism.

There appears to be considerable support in the Legislature for the concept of investment tax credits, as illustrated by the exploration credits, but obviously less support for the idea of a general tax reduction, mainly because of the lack of a guarantee. It would seem that a compromise, of some sort, would involve a tax change that reduces the overall tax rate, achieving the objectives of HB 110, but that is linked to some kind of performance guarantee.

It’s possible something like this could develop as the Legislature resumes work on the governor’s bill after Jan. 17.

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