Friday, March 23, 2012

Oil tax work continues; Consultants tell Senate Finance no positive impact on new production from SB192

Kristen Nelson
Petroleum News

Oil tax changes remain a focus for Gov. Sean Parnell and Alaska legislators, but as the session rolls toward an April 15 adjournment, the Senate Finance Committee is still working on Senate Bill 192.

The state’s goal for oil tax changes is to increase production on the North Slope.

Parnell put an oil tax bill on the table last year; House Bill 110 passed the House, but didn’t move in the Senate, which said it needed time to work the issues. This year the Senate took up its own proposal, SB192. After hearings and amendments in Senate Resources, that bill moved to Senate Finance.

The governor said March 20 that he is asking the Senate to put something on the table that will garner investment guarantees from the state’s oil and gas producers. On the time issue he noted that the Senate’s original schedule was to move a bill to the House with 30 days left in the session.

Senate Finance co-Chair Bert Stedman, R-Sitka, said March 20 that a committee substitute is at least a week away. He said the committee’s consultant has said the bill isn’t as effective as it might be at encouraging incremental oil production. Splitting of profit oil at high prices is another key issue, but consultants have said that at $100-a-barrel oil not a lot of modification is needed to make the state competitive. Stedman is concerned about pushing too much money across the table to the oil companies. He said industry told legislators a few years ago that they count every penny and said the state needs to do the same thing.

Stedman said a committee substitute is at least a week away.

As for how long it will take the House to consider a Senate bill, House Speaker Mike Chenault said March 19 that he expects it will be a week to two weeks before the House sees the Senate’s bill. It will probably be assigned to the House Resources and Finance committees for consideration.

Chenault said he didn’t know if the bill will be similar enough to HB110 to garner support in the House.

As to whether the House will have time to deal with it, he said a lot depends on how complicated the bill is.

If the House gets the bill with two weeks left in the session, Chenault said he didn’t know if that would be enough time. It depends on what’s in the bill and whether the House agrees, he said.

Another survey

In a public opinion survey done March 4-7 for the House, Dittman Research & Communications said March 19 that from a sample of 1,000 it found that 59 percent were in favor of repealing or modifying the state’s existing oil and gas production tax, Alaska’s Clear and Equitable Share or ACES. That compares with 58 percent in favor of repealing or modifying ACES last year.
The detail was 14 percent in favor of repealing ACES (compared to 20 percent last year) and 45 percent in favor of modifying ACES (compared to 38 percent last year). The number in favor of keeping ACES as is, 28 percent, was down this year from 35 percent last year, but the number unsure, 13 percent, was up from 7 percent last year.

Fifty-four percent of those surveyed said they believe that lower state taxes will generally result in greater business investment in Alaska, compared to 35 percent who think the tax rate has little effect on investment decisions and 11 percent who were unsure.

Democrats were almost exactly the reverse of the overall sample, with 34 percent of Democrats saying lower taxes result in more investment and 55 percent saying there was little effect.

The poll also asked respondents whether they favored the governor’s plan (described as “significantly” lowering oil taxes immediately to “encourage more investment and try to increase oil production now”) or the Senate plan (described as studying the issue further, making “only minor changes this year” and insisting on “investment guarantees from industry”).

Overall, 49 favored the Senate plan and 43 percent the governor’s plan, with 65 percent of Republicans (and only 21 percent of Democrats) favoring the governor’s plan and 74 percent of Democrats (and only 28 percent of Republicans) favoring the Senate’s plan.

There was a significant geographic break, with 56 percent of rural respondents favoring the Senate plan, while 55 percent of Interior and 47 percent of Southcentral respondents favored the governor’s plan.

New oil issues

PFC Energy, the consultants hired by the Legislative Budget and Audit Committee to work the production tax issue, told Senate Finance March 15 that the proposal in SB192 to encourage incremental oil production wasn’t very effective.

For a producer with 200,000 barrels per day of existing production, declining at 6 percent per year, it would take incremental oil of 100,000 bpd to produce a year-over-year increase, Jerry Kepes, partner and head of PFC Energy’s upstream and oil, told the committee. The incremental oil feature of SB192 is good for only a single year, so in addition to making up for an estimated 6 percent decline, a company would have to bring on substantial new oil every year to get above the normal decline rate.

Kepes said that even if new production is brought on very quickly, the proposed allowance for new oil only moves government take by fractions of a percentage point. For an existing producer, PFC’s models show that the net present value of the producer’s portfolio rises by about a tenth of a percentage point, where for a new producer, even though the impact on project value is greater, it is insignificant compared to the estimated $10 billion cost of a 100,000-bpd new development.

Kepes said an alternative, providing an allowance for new source oil, rather than incremental production over the previous year, could have a greater impact. The disadvantage, he said is that defining new-source production could be difficult in practice, and would be “a challenge for administrative capacity or regulatory capacity.”

Producers oppose two-tier approach

Senate Finance heard from the North Slope’s largest producers — BP, ConocoPhillips and ExxonMobil — on March 21.
The companies did not support a two-tier approach for existing and incremental production.

Bob Heinrich, vice president of finance for ConocoPhillips Alaska, told the committee that the discretionary production incentive does not incentivize the significant investments required just to offset decline and said it does not improve the investment climate.

Scott Jepsen, vice president external affairs for ConocoPhillips Alaska, said changes need to apply to all barrels — legacy as well as new fields — and make it simple. Only someone with no production would see a significant benefit under the proposal, he said.

Damian Bilbao, head of finance, developments and resources for BP in Alaska, said SB192 doesn’t work as an incentive for additional production. He characterized ACES as a failed fiscal policy which hasn’t delivered a track record of increasing investment. Bilbao said BP looks at the business holistically and starts with the base business: If that’s healthy, you get license to do more things.

It’s all production you want to incentivize, Bilbao said. A two-tier approach could end up discouraging legacy field development, and he said it’s rigs in the legacy fields that result in the most production.

Bilbao also told the committee that differentiating between existing and incremental oil creates unexpected results; he said it would be tremendously complex to differentiate costs. The way to incentivize new production is by making sure the base business is healthy.

Stedman told Bilbao that if changes in the oil tax don’t differentiate between new and existing production, legislators are concerned that they won’t be providing incentives for new production, that the state would move more cash than needed to industry and could end up where it is now in terms of production.

Changes to progressivity

SB192 reduces the rate of progressivity from a 0.4 percent increase to a 0.35 percent increase and reduces the maximum rate from 75 percent at $342 in production tax value (price less transportation and allowable costs) to 60 percent at $202 PTV.

Kepes said the impact on project economics of the progressivity change was relatively limited. He said there was a more appreciable change from the 60 percent cap at high oil prices.

ConocoPhillips’ Heinrich told the committee the 0.05 percent progressivity reduction does not improve the investment climate and said the 60 percent cap has no impact below an oil price of about $230 a barrel.

He noted that PFC Energy said the progressivity reduction would be limited to about a single percentage point at $100 Alaska North Slope oil.

Neither of the changes provides a robust environment for investment, Heinrich said.

Stedman said the committee would like ConocoPhillips’ thoughts on what the split should be between government and industry in the $70 to $150 per barrel price range, and asked if ConocoPhillips thought the split should be frozen at some point or if Alaska’s share should always continue to grow. Jepsen said ConocoPhillips believes the split should be frozen at some point, but said they’d need to understand all of the other elements.

The $100 issue

Stedman noted the committee has heard from consultants that at an oil price about $100 the relationship of government take seems reasonable for current production. Heinrich said that compared to other places where the company invests in North America, the range where the split is reasonable is about $70.

Jepsen said decisions are not made on a single variable, but said when ConocoPhillips looks at making additional investment in Alaska they don’t see the upside. He said they get capital to pursue base business, but said it’s very difficult to attract capital to get another rig or two for the Kuparuk field.

Jepsen said ConocoPhillips doesn’t believe that SB192 changes the investment environment on the North Slope and suggested significantly reducing or bracketing progressivity. He also said changes should include the legacy fields because that is where the largest potential production gains are located.

Bilbao said BP believes that it could be doing more in Alaska, but needs to be competitive for funds. He said that overall SB192 does not move the needle on meaningful tax change, remaining very close to ACES. HB110, he said, represented the beginning of meaningful tax change, although he said BP believes the base tax rate of 25 percent is too high.

Asked by Stedman to define meaningful and significant change, Bilbao said the state would know it was meaningful when it got the results it wanted in terms of more investment. He said a change in progressivity was the single biggest thing the Legislature could do. If progressivity is BP’s number one issue, then bracketing would be number two, Bilbao said, and cited HB110 as an example of meaningful tax change.

Exxon remains committed

Dale Pittman, Alaska production manager for ExxonMobil, told the committee that Alaska has always been and continues to be a critical part of the corporation’s business.

He said there have been questions on the opportunities discussed by BP and ConocoPhillips in the event of oil tax changes and said ExxonMobil fully supports both of its operators, BP at Prudhoe Bay and ConocoPhillips at Kuparuk.

Significant investment is needed to stem decline in the state, and that is why ExxonMobil talks about the need for a meaningful change in the state’s tax policy, Pittman said.

He said investment decisions are really risk-management decisions based on commercial, technical, fiscal and regulatory considerations and tax reform would restore some balance to the risk profile. Pittman said ExxonMobil believes that passage of meaningful tax change would attract additional companies to the state.

He said ACES has many flaws, with progressivity being the most onerous.

The state has benefited from short-term revenue increases under ACES, but has failed to attract investment, Pittman said.

Asked by Stedman about the progressivity issue at high oil prices and the possibility of freezing the split between government and industry, Pittman said what ExxonMobil focuses on is total government take. There are different levers, he said, but as a long-term investor ExxonMobil is fairly indifferent to individual changes, focusing instead on how projects can be made viable.

At $100 oil, dollars are not coming to Alaska, Pittman said, adding that it causes him some concern and he wonders how broad an opportunity the state wants.