|
Not all independents favor proposed tax Chevron has both Cook Inlet, North Slope production; Anadarko an explorer with production; Pioneer lured with severance tax Kristen Nelson Petroleum News
Independent oil and gas companies and explorers have different concerns about the governor’s proposed production profits tax.
The Legislature’s House and Senate Resources committees heard March 1-2 from Chevron, Anadarko Petroleum, Pioneer Natural Resources, UltraStar Exploration and AVCG/Brooks Range Petroleum. Chevron: assets in both basins Chevron acquired Unocal in 2005 and the committees heard from John Zager, general manager of Chevron’s assets in Alaska. Chevron is the fourth largest producer in Alaska, Zager said, and the third largest operator, and while it has nowhere near the production of the majors on the North Slope, it is big enough to be treated a lot like them under the proposed petroleum tax and not small enough to get the advantages built in for small companies.
Chevron is also, he said, the only producer in the state with a relative balance of assets between Cook Inlet and the North Slope, roughly 60 percent in the inlet and 40 percent on the slope. Both asset areas have production large enough to trigger the PPT, he said, i.e. the company’s production would not be covered by the proposed $73 million a year exemption from the proposed production tax.
Because Cook Inlet is a mature oil province, the company’s Cook Inlet offshore assets are “uniquely positioned” to suffer from the PPT, Zager said. Cook Inlet oil has direct lifting costs of $20-$25 per barrel of oil equivalent, a current breakeven on cash flow at about $30 per barrel and a breakeven on earnings at about $45 per barrel.
Asked by Rep. Les Gara, D-Anchorage, if he meant that the company was losing money at $18-$20 per barrel, Zager said in certain areas the company is. Two platforms have been shut down and others are about at breakeven. The decision was made to keep the other platforms operating because once the decision is made to shut down a platform “it’s irrevocable” so the company erred on the side of keeping them going. “At current prices that was the right decision,” Zager said. But there are significant costs to keep Cook Inlet operating: If one platform becomes uneconomic, those costs have to be shared among the remaining platforms, reducing their economics. It’s a “cascading effect,” he said. Chevron: Cook Inlet oil marginal Cook Inlet oil is very marginal, Zager told legislators, and can’t afford an additional tax.
He said Chevron had recently made the decision to retain all of Cook Inlet’s assets (see story in March 5 issue of Petroleum News), but incremental investment opportunities were analyzed several months ago under the existing tax regime.
When those same projects were modeled under PPT, “It affected the economics of our projects,” he said.
What had been the best projects “became less attractive” because they would pay additional tax. The economics for projects which just made the cut got better because they didn’t have a lot of profits but benefited from the capital credit.
Asked by Rep. Ethan Berkowitz, D-Anchorage, how the projects were impacted, Zager said there were more than 50 projects evaluated and on a better project the internal rate of return dropped 5 percent under the PPT, while a project with a poorer expected return might show a 3 percent improvement. When you add them all together under a 20 percent tax and a 20 percent credit, the whole package was degraded some, Zager said.
Berkowitz asked how the PPT could be tailored. Zager said the 20 percent tax is what affects the economics of the company’s programs: It takes net present value away in the out years. A change in the credit rate, Zager said, would improve the economics for incremental investments.
For Chevron, he said, lowering the tax rate or raising the credit or both would make more of the company’s Cook Inlet projects economic.
The way Chevron models the PPT “it’s a huge increase in taxes,” Zager said. “It looks like a minimum of a two times severance tax increase and depending on some of these other changes ... could be up to four times.”
Zager also said Chevron was concerned about misalignment in Cook Inlet, where the company has partners in all major investment opportunities. There will be a financial “disconnect” with partners because of the $73 million, he said: It will be a benefit to some on investments, while for Chevron it would be absorbed by the company’s existing production. Chevron: Cook Inlet should be treated differently Zager said Chevron believes Cook Inlet must be treated differently under the PPT. Chevron is the only company with a Cook Inlet-North Slope production balance, and believes its Cook Inlet production will bear the full weight of the PPT while partners and competitors in Cook Inlet will be “under the umbrella” of the $73 million standard deduction.
Zager said Chevron will support the bill if Cook Inlet — or the state south of the Brooks Range — receives its own $73 million exemption and if the PPT rates are changed to lower the tax rate and/or increase the capital credit.
Rep. Norm Rokeberg, R-Anchorage, asked Zager if the effect on Cook Inlet gas wouldn’t be different than that on oil, and Zager said that was correct. While Cook Inlet oil is a low-margin business, Cook Inlet gas “couldn’t make the same argument.” It’s no more challenged, he said, than North Slope gas.
Committee Co-Chair Ralph Samuels, R-Anchorage, said it has been argued that the $73 million takes care of Cook Inlet and asked Zager if it would make a difference if Chevron operated just in Cook Inlet. Zager said that if Chevron operated only in Cook Inlet “I would take some comfort in the $73 million.”
In one scenario, Zager concluded, the state raises taxes too much and the pie shrinks because there is less investment. In the other, if it taxes too little, the pie could get bigger, but the state is the big winner in the long run if the formula attracts additional capital. Anadarko: Both production and exploration Mark Hanley, Anadarko Petroleum’s manager of public affairs in Alaska, told legislators that Anadarko is in the middle between new guys and old guys because the company has production from the ConocoPhillips Alaska-operated Alpine field where it is a partner and yet is primarily an explorer. It doesn’t get the advantage of the $73 million because that would be used up against its share of Alpine production, so on a new prospect Anadarko would not have the same tax advantage as a new company in the state, which has no production.
Hanley said looking back over the years that the ELF, economic limit factor, has been a part of the production severance tax, the state may have gotten more than its share because ELF is a regressive system, so the state takes a larger proportion at low oil prices. Now prices are up and the state is talking about a progressive system, where it takes more at higher prices. “We can support it because of downside protection,” he said. On the other hand, if it looks like the state would change back to a regressive system if prices drop in the future, that would be another matter, he said.
Compared to larger companies Hanley noted that Anadarko doesn’t have as broad a portfolio, and doesn’t have as much money to rotate things through its portfolio. If the state is hunting for revenue with a shotgun, hitting a big company hurts but could kill someone else, he said. Anadarko: Credit should be refundable As for the credits, Hanley noted that since Anadarko has production, it can use them, where explorers without production will have to sell them at a discount. “That is not a level playing field,” he said, and the state loses. He suggested legislators consider a refundable credit, since it’s going to cost the state money in the end when the discounted credits are turned in against production taxes.
He also said that at low prices there might not be a market for credits.
This is an equity issue, Hanley said, it’s one where the playing field is un-level: The state could at least expand the things against which credits could be used — such as corporate income tax or lease sales.
He also recommended that the state model its tax on the back end: As the state increases the tax rate, how much does the minimum economic field size go up, reducing the barrels produced?
Hanley said Anadarko tried modeling some of the same scenarios as Pedro van Meurs and got different results. He said a common understanding of the basics is necessary, and suggested some type of work sessions using a single model: “Let’s get assumptions on the same page,” he said, so the Legislature can make the policy calls. “Right now I think you’re going to have unexpected consequences.”
Hanley said Anadarko believes the administration put together a decent mix, but said the bill doesn’t work the same for old and new oil, heavy oil, exploration and frontier drilling. They have different risk sets, he said. Anadarko is looking for larger anchor fields while some companies are looking at satellite developments or at maximizing existing fields.
While Anadarko would pay more, the proposal “improved our economics and helps us on the down side.” And, he said, some of Anadarko’s prospects are more likely to get drilled under the PPT. Pioneer: Lured by severance tax Pat Foley, Pioneer Natural Resources Alaska’s manager of land, commercial and regulatory affairs, told legislators that when Pioneer was considering its first investments in Alaska, state officials were promoting the resource merits of the state, and also the fiscal policy including the ELF formula and exploration incentives.
Under ELF, Foley pointed out, only very large new fields pay severance tax. The exploration incentives were 20 percent or 40 percent for qualifying expenditures. Pioneer has invested heavily in the state, he said, and the company is “quite concerned” by the new tax proposal, believing it might be detrimental to Pioneer’s future investments in the state “and a departure from the fiscal system promoted to the independents by the state.”
Foley said Pioneer was pleased with the proposal for deductibility of transitional capital — capital expenditures over the last five years — and agrees with the administration that the PPT will provide positive incentives for new investment. He said Pioneer believes the investment credits will encourage development of marginal fields and entice more companies to Alaska and increase competition. More companies and more ideas will reduce the minimum economic size of prospects and grow the resource pie in the state, he said. Pioneer: Also favors refundable credits Asked by Samuels if Pioneer was concerned that the majors will buy up credits and drive down the price, Foley said that was “just the imperfect nature of a market” when there were so few potential buyers. He said he’s sold and bought credits and they typically do sell at a discount.
He said Pioneer would like to see the Legislature consider some kind of refundable credit — with limitations to protect the state’s cash flow. The program could even allow for a modest discount, he said.
He said while Pioneer believes the PPT as proposed by the administration improves Alaska’s competitive position with respect to other investments worldwide, the company believes Alaska also needs to consider competition with the Lower 48, especially gas, which is attracting huge investment. He urged legislators to take care in making changes in the administration’s proposal which might make Alaska less competitive.
He said the $73 million exemption from the production tax is a valuable component for small companies and new investors. Most new opportunities are small and infrastructure-challenged, he said, and combined with the exploration risk they require a huge investment in the state. Under the existing law it is unlikely an explorer would pay significant severance tax unless a huge field was discovered, he said, and said that with the $73 million exemption, the tax is closer to what it was when Pioneer was recruited to Alaska. UltraStar: Don’t jettison $73 million Jim Weeks, managing member of UltraStar, told legislators that he thought arguments in favor of the 20 percent tax, 20 percent credit had been well articulated, and said UltraStar supports the position of others on these issues.
With the realization that the $73 million allowance is proving a difficult pill, Weeks said he encouraged legislators not to jettison it, but to consider alternative incentives for development of smaller fields.
It’s generally recognized that the giant fields on the North Slope have been found, he said, leaving 10 million to 100 million barrel accumulations, which can be attractive to small independents.
A ceiling might be set defining the size of company that would qualify for the $73 million. Weeks said there is a precedent in the 1999 charter for development agreement between the state, BP and ConocoPhillips that made BP’s acquisition of ARCO possible. One element of the charter requires preferential treatment to small companies to a maximum rate of production of 5,000 barrels per day.
Weeks said if we did not have the charter, “I wouldn’t be here testifying.” He said its far-sighted provisions enabled UltraStar to look for small satellite accumulations.
He asked legislators to consider one of the items excluded from what can be deducted in calculating profits. Amounts paid for indemnification are excluded, he said, but small independents will need to indemnify facility owners and operators to process oil and need to purchase third-party, arms-length insurance to satisfy these requirements. Membership in oil spill cooperatives may also be required, and all could arguably be excluded, he said, in calculation of direct costs. AVCG: Economics improve at 20% Ken Thompson, managing director of AVCG/Brooks Range Petroleum told legislators that the proposed PPT could be good or bad for industry — it depends on the company.
For a small start-up exploration company the economics at a 20 percent tax rate and 20 percent credit are more favorable than the existing severance tax, he said, with improvement in near-term cash flow and rates of return. When he goes to raise capital investors look at the rate of return, Thompson said, and it’s very important to show potential investors that Alaska is encouraging exploration.
Thompson said he agrees with a 20 percent tax; the proposed 25 percent rate, he said, takes too large a chunk of positive cash flow away from small companies. The 20 percent investment tax credit is essential, he said. His company plans a $46 million exploration investment over the next three years, and could spend $250 million to $500 million if they have a discovery, so the tax credit allows the company to put money back into exploration. Thompson said he hopes the Legislature keeps the $73 million standard deduction, but said he recognized it seemed to be difficult to get alignment behind $73 million with the public, and suggested using 5,000 barrel per day of production as the exemption. That makes it easier, he said, for the public to understand that while a company with 300,000 bpd of production still gets the deduction, they are also paying the severance tax on 295,000 bpd.
Thompson said he would like to see the tax credits funded by the state from a pool of dollars from the PPT, and said if the state did that it might want to stipulate that the credits be re-invested in exploration or development; his concern, he said, is that the market might reduce the value of credits to as little as 70-75 percent of face value.
Like Weeks, Thompson had concerns with the exclusion of indemnification and bonding from deductible expenses.
| 