Saturday, March 3, 2012

Senate works on oil taxes; passage this session in doubt

By Tim Bradner
Alaska Journal of Commerce

The state Senate had planned to continue work on its proposal for oil and gas production tax changes through March 2. It was unclear whether the Senate Resources Committee would finish its work on the bill by the weekend, but several broad themes have emerged as to changes the Senate will attempt.

Even two Democrats on the Resources Committee, Sens. Hollis French and Bill Wielechowski, both of Anchorage, now support changing the tax, known as ACES, or Alaska’s Clear and Equitable Share, a named applied by Gov. Sarah Palin when she proposed the tax in 2007.

French and Wielechowski have previously been staunch supporters of the current tax. All of the proposals now being made attempt to modify the financial effect of the tax to induce more investment.

The state House passed its version of oil tax reform last year in House Bill 110, a proposal Gov. Sean Parnell supports. Senators rejected that approach, however, and have set to work a counter proposal.

Legislators will be mostly gone from Juneau the week of March 5, many attending the Energy Council meetings in Washington, D.C., so the soonest the Senate Finance Committee can begin its work on the bill sent from the Resources Committee is the week of March 12.

Earlier, Senate President Gary Smith, R-Kodiak, had hoped to have the Senate tax bill passed and to the House by mid-March, in time to give the other chamber a month to consider the bill before the Legislature’s required adjournment April 15.

That schedule now looks virtually impossible. In a Feb. 28 briefing by Senate leaders Sen. Joe Paskvan, D-Fairbanks, co-chair of the Resources Committee, said only that he would like the get the bill out of his committee “as soon as possible.” Earlier Paskvan had expressed hopes that the bill could be to the Finance Committee by the time of the Energy Council break, which begins March 5.

Senate leaders said they want to move deliberately and do the bill correctly given the stakes. However, the delay could imperil any hopes of getting the oil tax bill passed in the regular 2012 session, which raises prospects that the work may have to be finished in a special session, if at all this year.

However, several Senate majority leaders are now on board that the tax has to be modified. Broadly, several senators are pursuing modifications of the progressivity formula in the production tax, a formula that ratchets up the tax rate as crude oil prices climb. This has been identified by industry and the state revenue department as the most troublesome part of the current tax, which is a net profits-type tax where the state tax applies to industry income after transportation and production expenses have been deducted.

A second change being pursued is a mechanism to lower taxes on new oil that is produced, compared to existing production, and a lower tax for oil that is difficult to produce or lower in quality, such as heavy oil.

Several senators are interested in changes to the exploration and development investment tax credits in the current tax law, thinking them too generous.

The bulk of the amendments before the Resources Committee, some of which will be included in a proposed committee substitute bill to be available March 2, were offered by senators the previous week.

Committee co-chair Sen. Joe Paskan, D-Fairbanks, asked PFC Energy, consultants to the Legislature, to develop models illustrating the fiscal effects of the amendments and to report the results to the committee.

Among the amendments offered are two by Sen. Lesil McGuire, R-Anchorage, which would establish a “bracketing” structure to the progressivity formula so the tax rate rises in increments, much like the federal personal income tax, rather than having a higher tax rate apply to an entire stream of production.

An alternative proposal by McGuire would have the bracketing apply only to new production. McGuire’s own analysis is that her proposal would lower taxes for industry by more than $1 billion by 2014, she told the Resources Committee.

In a presentation to the committee Feb. 28, Alaska Oil and Gas Association Director Kara Moriarty explained the problem in the current tax.

“One of the most egregious provisions of the current tax is the fact that as the price of oil increases, and as the higher tax is implemented, all prior dollars are taxed at the higher rate,” Moriarty said. “One approach to address this is through a bracketing concept that sets tax rates at different levels as the price increases so that each level is only taxed once, setting a specific rate for each bracket, thus moderating the impact of higher tax rates.”

Bracketing is included in the House-passed HB 110.

For their part, Wielechowski and French offered an amendment to cap the increase of the tax rate in the progressivity formula.

“I have become persuaded that our tax is now on the high end,” Wielechowski said.

French agreed, and co-signed the amendment with Wielechowski.

However, both Wielechowski and French said they want to see the fiscal effects of the change modeled before making a final decision.

“I will be very cautious in adjusting the progressivity (formula) because there is no guarantee of investment. I am now persuaded we are on the high side (in tax rates compared to other producing regions) but I’m still going to be a foot-dragger in this,” French said in the discussion before the committee.

French said he hopes to solve the problem of a guarantee of increased investment through another amendment that would reward the production of new oil. This would be in the form of an allowance that involves tax relief for new oil production that is measured above a base rate in an existing field.

This basically follows a recommendation by consultant Pedro van Meurs, but French said he felt van Meurs’ proposal for five allowances for new oil, including heavy oil, was too unwieldy.

“We’ll work to come up with something” that is similar but simpler, he said.

“The basic principle is that there is no reduction in taxes without new production,” he said.

Sen. Tom Wagoner, R-Kenai, has offered an amendment for a tax holiday for new oil that is similar in concept to that put forth by French. Wagoner worked with industry tax specialists over the summer on technical aspects of the bill to ensure that it would function properly.

He is not wedded to his own idea, however.

“If French’s approach is simpler, I can support that. I can go either way. I haven’t seen the modeling (of fiscal effects) on my idea, either,” Wagoner said.

The problem with rewarding new oil is how to define it. House Bill 110 has a reward for new oil by allowing a tax reduction for new oil development outside existing fields, which is a simple way to do it.

However, producing companies and consultants have told lawmakers that a great deal of new oil production can be done within the existing fields, both in squeezing more oil from the currently producing reservoirs and developing new, untapped deposits that are known but undeveloped within the field areas, like heavy oil.

Consultant van Meurs suggested a way to measure new oil in existing fields that is done in some other producing regions, by measuring the decline rate in the field and then allowing a reduced tax on any oil produced that is above the measured decline rate, which would be classed new oil.

In the committee discussion, Wielechowski said how the decline rate is set and who sets it would be critical to making such a mechanism work. There must also be allowances for interruptions in production, which would affect the decline rate, he said.

However, the concept is worth pursuing, based on van Meurs’ statement that other producing regions have made such approaches workable. Whether the idea or something similar winds up in the final proposal being developed by the Resources Committee is uncertain, but senators are clearly searching for some way to reward investment in new production, particularly in the existing fields.

Another idea Wielechowski proposed, in the form of a proposed amendment, is a minimum floor to the tax that would give the state assured revenues in case oil prices were to fall. The idea of a minimum was hotly debated when the Legislature adopted the ACES tax changes in 2007 but was rejected.

“We adopted ACES without this because we felt there was so much money at the high end,” meaning the state would be so well compensated at higher oil prices under the tax that it could take the risk on the low end of prices, Wielechowski said in discussion at the Resources Committee.

“What we didn’t contemplate (in 2007) is that the tax would become too high at the higher oil prices,” he said.

In proposing a mechanism for a floor at lower oil prices, Wielchowski would balance the giving up of some revenues at higher prices for a guarantee at lower prices. “We need a tax system that is durable,” in both price environments, he told the committee.

Wielechowski reminded the committee that Alaska North Slope oil was priced at $39.01 per barrel in January 2009. Also, with the investment tax credits currently in effect, there could be situations, in a low oil price environment, that the state would actually be paying industry rather than the other way around, the senator said.

French said he would like to cap the tax credits so the state paid no more than 65 percent of the cost of a new project under all oil price situations.

Sen. Bert Stedman, R-Sitka, said consultant van Meurs had told lawmakers that under certain high price scenarios the tax credits could result in the state paying 100 percent of the cost of projects, or even more.