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Certainty vs. credibility vs. stability State of Alaska doesn’t need fiscal certainty, consultant tells LB&A; does need fiscal credibility and record of fiscal stability Kristen Nelson Petroleum News
International oil companies want to be sure projects involving large investments will be commercial — that government won’t increase taxes over time and take all the profits once the investment has been made, David Wood of David Wood & Associates told the Alaska Legislature’s Budget and Audit Committee in a November report.
Alaska doesn’t need to make fiscal commitments over the life of a project, but does need to show “fiscal credibility,” Wood said in the conclusion to his report, and assure producers that the state’s production tax changes in 2006 and 2007 “are not the prelude to repeated future increases in tax rates that will continuously reduce the commercial viability of future gas field developments.”
But “Alaska does not need to commit to keeping all elements of its fiscal design fixed for decades in order to attract investors to build a gas pipeline and develop large gas fields” in today’s international conditions, he said.
Wood contracted with LB&A in April to do a report on fiscal designs for the development of Alaska natural gas. He presented his preliminary report in November and described it to LB&A at an Anchorage meeting in early December (see part 1 of this story in the Dec. 21 issue of Petroleum News).
Rep. Ralph Samuels, R-Anchorage, the outgoing chairman of LB&A, said he asked Wood to look at the big picture, and Wood looked at natural gas fiscal systems worldwide, focusing on “long-distance gas supply chain projects” which, like Alaska’s proposed North-Slope-to-market natural gas pipeline, are designed to serve the export market.
Definition of terms Wood distinguished fiscal certainty, fiscal credibility and fiscal stability.
Fiscal certainty refers “to a high level of legally enforceable confidence from taxpayers, underpinned by a law or a contract, where the fiscal terms are not going to be changed over a specified planning horizon.”
Such surety usually requires a contractual agreement, fiscal statute or constitutional amendment, and Wood said he does not believe Alaska needs to provide fiscal certainty in order for a major gas line project to be built.
Fiscal credibility, on the other hand, “is a perception” and reflects the view of taxpayers and the public that fiscal policies of a government are “consistent and the fiscal burden placed on major industries predictable in terms of a stated fiscal strategy” including clear objectives for sovereign take, industrial growth incentives, resource development, expanded employment opportunities and improved local skills, Wood said.
Crucial here is that strategies are being pursued with long-term consistency. If changes are made frequently — and “with little discussion and consultation with major taxpayers by new political leaders with short-term objectives” and without regard for long-term consistency, and if fiscal policies are perceived as “inconsistent, unpredictable and without clear long-term objectives it is safe to conclude that the taxing authority lacks credibility among its major taxpayers,” Wood said.
Stability a perception Fiscal stability is also a perception, he said, one backed up by historical performance and requiring “the taxing authority to have a track record of prudent fiscal policy, not necessarily one that has not been changed for many years, but one where the changes have been prudently considered with wide discussion involving all stakeholders and with clear long-term development objectives sought in the best interest of all taxpayers and without rendering some industry assets sub-commercial,” Wood said.
“Fiscal stability requires fiscal credibility, but not fiscal certainty,” he said.
Alignment between major taxpayers and the taxing authority involves “a combination of fiscal incentives and progressive taxes that lead to an equitable and sustainable share of economic rent in both highly profitable and marginal projects,” Wood said. Regressive taxes such as royalties — those that do not change with the price of oil or other factors — can lead to projects with sizeable reserves becoming marginal from the perspective of the taxpayer or investor.
Regressive taxes can provide “high fiscal revenues to the government but no positive return to the taxpayer even at quite high unit product values,” and Wood characterized regressive taxes as “unsustainable in terms of promoting resource development over the long term” as well as “not conducive to growing fiscal revenues.”
Recommendations Wood recommended that a fiscal design for an Alaska natural gas tax “should focus on addressing not only increased take through a better-focused gas progressivity element, but also mitigate some of the regressive elements in the prevailing fiscal design.”
A design for a natural gas tax should also be clear on its forward-looking strategy and “aim to align with producers to make a wide range of gas field developments commercial.”
Wood said a gas fiscal design should aim for stable fiscal environment “and flexible fiscal instruments that do not require frequent tinkering.” He said the goal should be to develop the state’s natural gas resources in ways that are “profitable and sustainable” for the state and for the producers.
While offering producers some guarantees on fiscal take might accelerate investment, “guarantees involve risks for the state which this author does not believe are essential to secure investment,” Wood said, “especially if a clear fiscal strategy is adopted and communicated and the overall fiscal adjustments introduced for gas make the design more progressive and encourage developments to achieve commerciality.”
Alaska’s advantage Wood said a factor in Alaska’s advantage is that many international oil companies want to invest in large gas field development but face competition globally from national oil companies. Other gas development projects have tough fiscal terms and high political risk.
Once the commitment is made for a gas pipeline, Wood believes that many non-U.S. companies — national oil companies, international oil companies and independents — could be attracted to invest in Alaska’s upstream and downstream.
“There is no reason why just a few major companies should dominate Alaska’s natural gas industry in the long term,” he said.
Major international oil companies are struggling to replace reserves and mineral-interest fiscal systems, like that in Alaska, “enable them to book more reserves than production-sharing systems that are common in many large gas producing countries.”
Wood said that in the long term Alaska needs to design its upstream gas fiscal system for both large and small companies and projects if the state wants to maximize competition.
“In the short term the emphasis might need to be on how to bring the proved gas reserves of the North Slope into production and supplying a future gas pipeline efficiently,” he said.
Because large-scale remote gas development projects are capital intensive, fiscal terms should reflect the high costs and long lead times of such projects. Wood said fiscal terms need to be both flexible — providing “sustainable commercial returns to investors for many field sizes and in a range of market conditions” — and “truly progressive,” providing increased percentage returns to government when projects are highly profitable “due to high prices, low costs or following payback of initial and incremental investment” while providing a lower percentage to government when project profitability is limited.
He said the state’s current combined progressivity tax for oil and gas, combined with regressive taxes — royalty, property tax and production tax floor — make the overall tax system regressive and make gas fields of less than 1 trillion cubic feet “uneconomic or marginal for producers while yielding high fiscal revenues to the state.”
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