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Senate to study gas tax over interim Consultants David Wood, Dan Dickinson, brief Senate Finance, Resources, on benefits of separate natural gas production tax Kristen Nelson Petroleum News
Alaska legislators are unconvinced by the administration’s view that the current production tax system will work for large natural gas sales and are working with consultants to look at options for a separate natural gas production tax.
With TransCanada Alaska planning to conclude an open season for its Alaska Gasline Inducement Act gas pipeline in July 2009, any gas tax adjustments would need to occur in the 2009 legislative session, as the Legislature committed in AGIA to honor the gas tax system in place at the time of an initial open season for the first 10 years of gas sales for gas committed during that initial open season.
Late last year consultant David Wood presented the results of a study of how the current production tax, applied to natural gas on a barrel-of-oil-equivalent basis, would affect revenues when natural gas volumes were rolled in with oil for production tax purposes.
Sen. Bert Stedman, R-Sitka, co-chair of Senate Finance, told a joint meeting of the Senate Finance and Resources committees March 26 that this year Wood will be studying the Prudhoe Bay, Kuparuk and Point Thomson fields, “which will give him a better feel for Alaska-specific issues.”
“So, we’re in the very beginning of this process,” Stedman said.
Wood, of United Kingdom-based David Wood & Associates, looked at tax issues for hypothetical oil and gas fields in the study he completed in 2008.
Stedman said a request would be put to the Legislative Budget and Audit Committee for the further analysis by Wood, with a preliminary discussion of results planned for late summer or early fall and a final report by mid-November.
Less tax revenue if gas sold? Wood has been working with Dan Dickinson, an Anchorage-based CPA and a former director of the Department of Revenue’s Tax Division.
In an example prepared by Dickinson from Wood’s 2008 analysis, high oil prices and low natural gas prices, calculated for equal volumes on a boe-basis, resulted in the state receiving less revenue when natural gas production was added than for crude oil alone. The result occurred because with the price disparity and equal volumes of oil and natural gas, the low-priced natural gas sharply reduced the progressivity rate. Progressivity is a portion of the production tax which is only applied above certain profit levels.
The administration responded in February with an analysis by consultant Rich Ruggiero of Gaffney Cline & Associates.
Ruggiero did not use equal volumes of oil and natural gas in his analysis, but instead used the volume of crude oil industry expects to be producing when natural gas sales begin through a North-Slope-to-market natural gas pipeline, combined with the volume of natural gas expected to be shipped down that gas pipeline.
Ruggiero also looked at prices over a range of years — Dickinson had done a snapshot view, looking at what would happen at a specific level of crude oil and natural gas prices.
Ruggiero told legislators that over the range of prices and production levels projected for an Alaska gas pipeline (data prepared by other administration consultants for AGIA hearings last summer), instances where the state received less tax for a combined stream of oil and natural gas than for oil alone would be infrequent.
The audit issue A number of other issues were discussed during Wood’s presentation.
When the Legislature revised production taxes in 2006 and 2007 there was concern about auditing oil company expenses. Specified expenses are deductible from the tax base under the new production tax system and legislators were concerned that oil and gas companies would “game” the system and try to include items which shouldn’t be included, complicating the state’s audit of taxes.
Sen. Bill Wielechowski, D-Anchorage, asked Wood about accounting issues if oil and gas are de-linked for tax purposes. The administration has said that taxing oil and gas production separately would create auditing difficulties because costs would have to be separated by product.
With oil and gas intermingled at Prudhoe Bay and Kuparuk, “the thought is that this would create a tremendous accounting nightmare for the administration to try to administer — which expenses come from oil, which expenses come from gas,” Wielechowski said, and asked Wood if separation of costs is an issue in other countries, and how it is dealt with.
Wood said “the industry is used to separating and allocating costs in a whole range of situations,” including fields where multiple reservoirs “are developed separately and costs allocated separately.”
There are many ways this can be handled, Wood said, “The simpler the better, so you may have to make some approximations.”
“There is an accounting issue there, but it doesn’t have to be a nightmare,” Wood said.
Fiscal stability issue Sen. Hollis French, D-Anchorage, noted that fiscal stability has been a big issue in Alaska fiscal system discussions and asked Wood, “how much fiscal stability should we be discussing?”
Wood said “if you have a fiscal design that is flexible and has progressive elements and also some regressive elements to provide security of base-level revenues ... that design can significantly reduce the need for a clause that guarantees that the fiscal regime is not going to change.”
He said if a fiscal system is flexible and structured to work “over a wide range of economic conditions and production conditions, then the need for a guaranteed statement of fiscal certainty falls away.”
But when the project requires an investment of billions of dollars and a decade or more before returns are achieved on that investment, “then it may be necessary to enter into clauses that guarantee certainty for a period of time.”
Wood said if a government has to offer such guarantees, it should make sure the system has regressive elements adequate for changing requirements.
Regressive elements in the state’s fiscal design include royalties, property taxes and a production tax floor: Producers pay these irrespective of the price they get for the oil and gas they sell.
Progressive elements result in higher tax revenues when prices rise and lower revenues when prices drop. The progressivity element in the state’s current production tax, for example, is only paid when the value at the point of production, the sale price less allowable production and transportation costs, is above a certain level.
Risky for government Asked by Wielechowski if de-linking oil and gas production taxes would open the state up to accusations of creating an unstable fiscal environment by changing the tax system, Wood said it is true the state has changed its fiscal system several times and that has drawn criticism.
He said if the state clearly identifies changes being made as “beneficial to the overall structure” and if the structure is being changed so it more accurately reflects the production forecast and targets credits at gas development or at specific fields, then those “clear strategies” somewhat overcome the criticism of frequent changes in the system.
“But clearly that issue has to be addressed,” Wood said.
Wood said in his presentation that issuing guarantees of fiscal certainty is risky for governments and said a “flexible and progressive” fiscal design is a better solution.
Guarantees that are offered should involve limited time periods; commitments from companies for ceilings on costs; and more regressive fiscal elements than if no guarantees are given, Wood said.
He also recommended that governments retain the right to adjust fiscal terms so the fiscal design can be changed periodically in response to changing market conditions.
Progressivity an issue with gas Wood said Alaska’s current production tax is a problem from the natural gas perspective for several reasons.
Large volumes of natural gas dilute the production tax value (the point of production value, which is the destination value minus treatment, tariff and transportation); the value at which progressivity kicks in is set too high for natural gas; and tying the production tax floor to the production tax value can lead to regressive consequences for gas producers in conditions where costs are high and values are low.
Natural gas dilutes the production tax values from oil because of the magnitude of difference in value between oil and gas, Wood said in his presentation, and because of the relative volumes of oil and gas which contribute to a combined production tax based on barrels-of-oil equivalent.
Gas different than oil Wood summarized his base case work done last year on 10 hypothetical fields, five gas and five oil, by saying “the world of the oil field is quite different than the world of the gas field in Alaskan terms.”
In the hypothetical oil fields the government take of the gross destination value was about 60 percent and the net government take, after costs are removed, was “about 75 percent of the profitable portion of the cash flow.”
With gas, however, the government take on the gross destination value was only 30 percent and the government take on the profitable part of the cash flow was about 67 percent.
The reason for the difference, he said, is transportation.
In a hypothetical gas field, more than 50 percent of overall revenue is taken up by field costs, capital costs, operating costs and transportation costs. The transportation cost is a significant part of this: 42 percent for TT&T (treatment, tariff and transportation), compared to 4 percent for operating expenses and 6 percent for capital expenses, plus 1 percent for TT&T for liquids associated with the gas.
In an oil field, by comparison, TT&T costs are 5 percent for liquids and 6 percent for associated gas, and total costs, including 5 percent capital expenses and 7 percent operating expenses, total less than 25 percent.
Wood said that is why total government take for Alaska plus the federal government is some 60 percent compared to 30 percent of total revenue in a gas field.
“I think it is important to realize that the ... world of gas is quite different from the world of oil primarily because most of the costs are in this transportation element,” he said.
Wood said this is another argument for taxing oil and gas separately.
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