Friday, March 1, 2013

Revisions to oil taxes; CS moves from Senate Resources to Finance

—Kristen Nelson

A committee substitute for Alaska Gov. Sean Parnell’s oil tax bill has moved to Senate Finance, its third committee of referral. The bill underwent significant revisions in Senate Resources with major changes aimed at flattening the level of government take across different oil prices and focusing credits on production rather than spending.

The bill moved out of Senate Resources Feb. 27 on a party line 5-1 vote.

Resources Chair Cathy Giessel, R-Anchorage, said changes to Senate Bill 21 in the committee substitute were the result of concepts from the TAPS Throughput Committee’s letter of intent and from individual committee members, as well as testimony from stakeholders.

On the House side, where the Resources Committee has been hearing the bill, co-Chair Eric Feige, R-Chickaloon, said Feb. 22 the committee would set aside House Bill 72, that body’s version of the governor’s bill, pending action in the Senate.

The Senate TAPS Throughput Committee heard SB 21 and took testimony but did not amend it, instead sending suggestions for changes to the Resources Committee in a letter of intent.

In a Feb. 22 walkthrough of the committee substitute or CS, Giessel described the first change as the “35-five element,” which increases the base tax rate from 25 percent to 35 percent, offset by a $5 per taxable barrel credit for North Slope production.

Sen. Peter Micciche, R-Kenai, co-chair of the TAPS Throughput Committee, said the goal was to respond to complaints about the original SB 21 that the state’s take was too high at lower prices and to concerns that SB 21 was slightly regressive.

“Our concept was to create a slightly progressive system without using progressivity” while preserving “the simplicity of the governor’s proposal,” Micciche said.

The CS achieves those goals “by raising the base rate and then offsetting it with the per-barrel credit,” he said.

Micciche said the proposal in the CS improves “economics on the low end and the price where we hear companies evaluate projects. And I like the fact that it’s slightly progressive without using progressivity and a little bit more for Alaskans (than SB 21) but not in a way that puts us out of the ballpark on being competitive.”

Giessel said the committee “didn’t want to create a runaway schedule of credits which would incentivize spending and not production,” and said that is accomplished by raising the base rate and providing the $5 credit per taxable barrel. The $5 per barrel cannot be carried forward and must be used against the tax liability for the year in which the barrel was produced.

Progressivity introduced in 2006

The governor’s proposal eliminated progressivity, a major feature of the state’s current oil production tax, Alaska’s Clear and Equitable Share or ACES, enacted in 2007. Progressivity was introduced in 2006 when the state moved from a tax on the gross to a tax on the net under the Petroleum Profits Tax or PPT, and was increased in ACES.

Progressivity increases the tax rate as oil prices rise, making Alaska’s tax system more progressive than regressive. The other major portion of the state’s oil and gas taxes, its royalty, a fixed percentage of production, typically 12.5 percent, is a regressive feature, steadily dropping the percentage of the state’s share as oil prices increase.

Prior to PPT the state’s entire production tax system was regressive. A major objective of the changes introduced in PPT and ACES was to give the state a portion of the upside as oil prices increase.

Competitive issues

The Legislature’s consultant on the oil tax issue, Janak Mayer of PFC Energy, told the committee Feb. 22 that SB 21 as it stood was a tax decrease at higher oil prices, but because capital credits were removed, at lower oil prices it was essentially a tax increase. The crossover point, the point at which SB 21 becomes a tax increase over ACES, along with the regressive nature of SB 21, are what the CS tries to address, Mayer said.

With the CS you see “a much flatter level of government take” for base production for an existing producer at mature fields, but, he said, for new developments outside of existing fields, there is a slightly lower level of government take due to the gross revenue exclusion, a tax reduction for new barrels that is part of SB 21.

Overall, for base production, government take under the CS looks “very flat, very neutral and right on where I think a lot of people are looking to go in terms of overall levels of government take,” Mayer said.

But looking at the details of new developments, he said there appear to be “things one might want to look at further to see what can improve the way the overall picture works.”

Credit tied to production

Barry Pulliam of Econ One, the economist working with the administration, said the effect of the changes in the CS is to increase government take from the low 60 percent range to approaching 65 percent at oil prices above $80-$90 a barrel “and to reduce government take at prices below $80 a barrel down closer to what it was under ACES.”

He said the CS “bends the curve just a little bit and accomplishes at least what we’ve heard are the goals of providing some lower taxes at lower levels, getting closer to what ACES had, and a little bit higher at higher levels, closer to what you see on average throughout the world.”

Micciche asked if the change in the CS would help “in analyzing projects in the price range where companies evaluate projects?” Pulliam said it would by providing “additional support at the lower price range” without “getting into the messiness of a progressive net tax.”

Pulliam said one of the things he liked about the system under the CS is that “the allowance or the credit is tied to ... production. And the value of it increases at lower prices and fades away at higher prices where you don’t really need it.”

He said he looked at the impact on new developments. For a lower cost new development the government take “would be right about 60 percent ... a very competitive take” and while it isn’t as attractive for a higher-cost new development, “it’s more attractive under this proposal than it is under SB 21.”

“So I think it accomplishes a lot of what ... you’re looking to do and supports the producers’ economics in an important and meaningful way,” Pulliam said.

GRE expanded

Another change in the CS is the expansion of the gross revenue exclusion to include new oil in legacy fields. The gross revenue exclusion, or GRE, was a concept developed late in the last Legislature to provide tax relief for new oil.

It was included in the governor’s bill for oil from new fields at a 20 percent rate, and increased to 30 percent in the CS to balance with the increase in the base tax to 35 percent.

Joe Balash, deputy commissioner of the Department of Natural Resources, said the CS adds to ways in which a producer could qualify for GRE by adding new participating areas or expanded participating areas.

Leases are organized into units to manage multiple leases which contain an oil or gas reservoir, Balash said. Participating areas are the portions of the unit which are actually contributing to production — as determined through reservoir engineering and analysis.

New participating areas, he said, would be “parts of the unit that are not today contributing to production — and so by definition would be new production.” This would also be true of expanding existing participating areas, “again,” Balash said, “we’re talking about land that previously was not determined to have been contributing to production.”

Balash noted that the burden of demonstrating that barrels are new oil would lie with the company.

The CS also contains a wording change identified as an issue by Brooks Range Petroleum Corp., Balash said. A reference to new oil being from “land” that was not within a unit on Jan. 1, 2003, has been changed to read a “lease” that was not in a unit. Some of the leases Brooks Range holds today were formerly part of the Kuparuk River unit, but were contracted out of the unit and re-leased to Brooks Range, so “we had to be specific as to the lease, not the land,” Balash said.

Competitiveness review board

The CS also contains an element proposed by Sen. Lesil McGuire, R-Anchorage, creating a competitiveness review board.

McGuire said this is a proposal she’s made for a couple of years, based on her experience of 13 years in the Legislature and seeing how politicized oil and gas tax discussions become.

The board would include nine members: the commissioners of the departments of Natural Resources, Revenue and Environmental Conservation; the chair of the Alaska Oil and Gas Conservation Commission; and five public members appointed by the governor, including a petroleum engineer, a geologist, an economist, and two members, each nominated by different leading nonprofit trade associations representing the oil and gas industry in the state. The board would meet at least four times a year and “they would make recommendations to the Legislature about how to keep Alaska competitive,” McGuire said.

The Legislature would still be making the decisions, she said, but it would get a report from the board.

Exploration tax credit

Both Brooks Range and the Alaska Oil and Gas Association told the committee that they had concerns with the exploration tax credit, Giessel said, concerns addressed in the CS.

The current exploration incentive credits are set to expire in 2016 and the CS extends them to 2022. The CS also eliminates the requirement that an exploration well be three miles from any existing well.

Brooks Range told the committee that because they were working close to existing units, none of their exploration wells qualified for the exploration credit.

Balash told the committee that the CS eliminates the distance requirements for an exploration well to qualify for a credit.

Under the CS the commissioner of the Department of Natural Resources is required to determine that the well’s target is something new, actually a technical determination which would be made by the Division of Oil and Gas, he said.

That provides a frontend gate, Balash said, “to make sure that in fact something new is being looked at or looked for in order to qualify as an exploration credit.”

Then there is a backend gate, which requires accounting for the costs and sharing of information from the well with DNR to qualify for the credit and receive it.

“So there’s a check on the frontend and a check on the backend, making sure that we as a state get something” for what he noted had been described as a generous credit in which the state takes a certain amount of exploration risk along with the company.

Credit for Alaska manufacturing

Another element suggested by the TAPS Throughput Committee was a way to encourage Alaska hire and Alaska purchase, Giessel said, and is addressed in the CS with a corporate income tax break for Alaska manufacturing.

The CS includes a corporate income tax break for oil and gas sector goods made or modified in the state with a $10 million cap.

Deputy Revenue Commissioner Bruce Tangeman said this would be for “expenditures directly attributable to in-state manufacture or in-state modification of tangible personal property used in exploration, development and production of oil and gas.” He said it is “a very targeted tax credit” with a 10 percent corporate tax credit against expenditures going into the item.

Michael Pawlowski, advisor for petroleum fiscal systems to commissioner of Revenue, told the committee that one of the things heard consistently in the testimony on the bill has been “the impact of the high cost of doing business in Alaska on the oil industry,” and with the state’s net tax system there is a relationship between a “vibrant service industry and support industry” and a healthy oil industry. He said one of the attempts of this addition to the CS “is to increase the health of that sector and hopefully drive down costs.”

Pawlowski noted that the CS specifically excludes minor product modifications and inventory activities.

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