Tax impacts on exploration, production differ

Econ One looks at likely impacts on different activities from proposed State of Alaska tax/credit rates of 20/20 and 20/25

Kristen Nelson

Petroleum News

Impacts of the governor’s proposed production profits tax could be different on explorers than on producers, economists representing Econ One Research told legislators March 13.

At low oil prices, for example, a 25 percent profits tax and a 20 percent credit rate helps companies that are exploring more than a 20 percent tax rate and a 20 percent credit.

Why is this?

Tony Finizza, an economist working in conjunction with Econ One, told legislators that it’s because the explorer has a negative cash flow for so many years before it has any production, it is marginally better off with 25/20 than with 20/20.

Finizza, a Ph.D. in economics and finance from the University of Chicago, and chief economist for ARCO from 1975 to 1998, said that unless the coastal plain of the Arctic National Wildlife Refuge is opened to exploration, large oil discoveries on the North Slope are unlikely. But incentives are required at low prices, and either the 20/20 or the 25/20 proposed PPT would be an improvement over the status quo as an incentive to exploration. And under either of the proposed tax and credit rates the remaining resources are economic, except at low prices of less than $30 a barrel.

How an explorer looks at prospects

He used estimates from the U.S. Geological Survey of a mean of 4 billion barrels for technically recoverable undiscovered oil on the central North Slope vs. 10.4 billion barrels in ANWR.

But on the central North Slope the USGS estimates that 51 percent of that oil will be found in fields with fewer than 64 million barrels, none in fields over 1 billion barrels and only 2 percent in fields over 500 million barrels. The USGS mean for undiscovered central North Slope fields (excluding ANWR) is 21 fields of 50 million barrels (60 percent), 11 fields of 100 million barrels (25 percent), four fields of 150 million barrels (10 percent) and one 500 million barrel field (five percent).

At $30 oil prices, the USGS estimates 860 million undiscovered barrels on the central North Slope would be economic, at $40 oil 1.89 billion barrels, at $50 oil 2.66 billion barrels and at $60 oil 3.2 billion barrels.

One in six chance of finding oil

The proposed $73 million standard deduction helps the economics of an exploration program, he said, but net present value calculations still come up negative at $30 oil prices based on drilling six wells to make a discovery.

Finizza told legislators that by giving incentives to exploration the state is basically stepping in and saying well, the market won’t do it, I’ll encourage it. The state is helping out, so “you could get exploration that won’t pay and you’re going to hold some of the bill on that.”

ANWR is a critical point, Finizza said: Without it, smaller sized fields will be found and incentives for exploration will likely be needed.

The proposed PPT likely would get the state more exploration, but he said it’s impossible to say how much, because the expected small central North Slope field sizes weigh against the economics. The PPT helps, he said, and incentives would help; both tax credit combinations work better than the status quo.

Majority in known fields

The reason the Legislature hired EconOne, Pulliam said, was to look at the work done by Pedro van Meurs and the Department of Revenue and tell the Legislature whether or not that work was reasonable. While different people will have different assumptions, that doesn’t mean either set of assumptions is unreasonable and Revenue’s numbers look reasonable, he said.

Pulliam said Econ One added Oooguruk to future production numbers, since that project has begun since Revenue prepared production figures in the fall. And he said he disagreed on the point of when the North Slope might shut down without a gas line. Econ One thinks, he said, that if oil is at $40, then the North Slope, particularly Prudhoe Bay, would be economic for longer than 24 more years. But, he said, he puts more emphasis on the next 10 years because changes out farther than that are so hard to forecast.

EIA forecast used for some work

Using Revenue’s worst case scenario — no ANWR and no exploration — and the EIA price forecast, Econ One estimated $29.255 billion from a 20/20 (20 percent tax; 20 percent credit) PPT tax through 2030, $17.971 billion more than the state would have received under the status quo, and an effective tax rate of 12.6 percent compared to 4.9 percent under the status quo.

At a $40 oil price, the state would earn $8.888 billion, $3.434 billion more than under the status quo, and have an effective tax rate of 10.2 percent, compared to 6.3 percent under the status quo. The breakeven point would be an oil price of $30.50.

Pulliam also presented a case where deductible costs are 20 percent higher, which moved the breakeven point between the PPT and the status quo to $34.60 per barrel, and resulted in severance tax revenues of $7.419 billion at $40 per barrel, an increase of $1.965 billion over the status quo.

The sliding scale

He showed tables of what kind of a change a sliding scale would make when added to the PPT at higher oil prices.

While the effective tax rate at $40 oil is 10 percent with a 20/20 PPT (2007 through 2030) compared to 4.9 percent under the status quo, that effective tax rate goes to 11.9 percent if the price of oil rises to $50 and a 0.30 percent increment kicks in at a $50 threshold price. (See story this issue on committee substitute prepared by House Resources, which includes a sliding scale.)

Consultant: $40 likely company base case

Tony Finizza, an economist working with Econ One Research, told legislators March 13 that he’s heard a lot of talk in Juneau about real high prices, $100 per barrel and higher, and real low prices, $20 per barrel, but doesn’t believe those are sustainable.

Finizza, who has a Ph.D. in economics and finance from the University of Chicago and was chief economist for ARCO from 1975 to 1998, said factors suggesting that prices aren’t likely to stay low include strong oil demand, especially in Asia, and the growing gap between global demand and non-OPEC supply, which will lead to increases in Organization of Petroleum Exporting Countries market power.

The factors opposing long-term higher oil prices include alternative sources of liquids at high prices, with tar sands, coal liquids and shale oil economic at, respectively, $20-$30 per barrel prices; prices above $30; and prices above $45-$50.

Because oil is primarily used as a transportation fuel, over the long run its position in that market can be eroded by hybrid vehicles, grid-connected hybrid vehicles and fuel cell vehicles.

Then there is the “consumer tax”: every $10 increase in the price of oil is like adding a $73 billion tax on consumers, and you don’t need many of those to tank the economy, he said.

Oil price forecasts

Producers have been burned by forecasts of high oil prices in the past, he said, and will test projects against a price well below their most likely view. Companies haven’t been willing to share the prices they use for planning for competitive reasons, but Finizza said there is evidence they are using around a $40 West Texas Intermediate price as their base and $30 WTI as a stress price, a price range that tends to be confirmed by recent asset sales.

—Kristen Nelson