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April 2006

Vol. 11, No. 17 Week of April 23, 2006

Finance rolls out CS

Compromise: Tax 22.5%, credit 25%, progressivity on net above $45 barrel

Kristen Nelson

Petroleum News

The Senate Finance Committee rolled out a committee substitute for Senate Bill 305, the production profits tax, on April 19, with a tax rate in between those proposed in House and Senate Resources committee substitutes and a progressivity rate tied to net profits.

Committee Co-Chair Lyda Green, R-Matanuska/Susitna, said the goal was to come up with something to keep everyone a little happy and everyone a little unhappy and to keep industry investing and producing.

Green said she wanted amendments April 20 and 21. She invited written response on the CS, and said she didn’t know if there would be time for testimony. She said the committee was on an ambitious timeframe with the bill, but was not trying to overlook anyone.

The administration’s proposal, SB 305 and House Bill 488, was introduced Feb. 21. Both House and Senate Resources held extensive hearings. House Resources moved a committee substitute March 22; Senate Resources moved its CS March 29.

The Finance committees have held numerous hearings.

The tax and credit rates proposed in the governor’s bill were both 20 percent and while it was generally progressive — the rate increased as oil prices increased — the original bill had no specific progressivity feature.

Resources committees added progressivity

The House Resources CS kept the tax and credit rates at 20 percent but added a progressivity surcharge on the gross at West Texas Intermediate prices above $50 a barrel.

The Senate Resources CS raised the tax rate to 25 percent, kept the credit at 20 percent and added a progressivity surcharge on the gross at Alaska North Slope West Coast prices above $40 a barrel.

The Senate Finances CS compromised on the tax rate, 22.5 percent, and raised the credit to 25 percent, with a progressivity surcharge on the net when that net (price less costs) is more than $45 a barrel, with a rate of one-tenth of 1 percent, lower than the other bills.

The transition treatment is the same as in the Senate Resources CS, a five-year look back for capital expenditures with a 2 for 1 recovery: for every $2 invested over the next 7 years, companies can claim $1 toward a 20 percent credit for capital expenditures in the five years prior to the tax change.

Green noted that natural gas is included under the PPT, but is taxed at one-third the gross value of the gas at the point of production, essentially a tax rate of about 7.5 percent.

Sen. Bert Stedman, R-Sitka, asked if the intent of the CS was to apply the same tax structure across the state and use the one-third rate to deal with gas and Green said that was correct: the CS would keep the structure the same.

Dan Dickinson, former director of the state’s Tax Division and currently a consultant to the administration on the PPT, said from an administrative point of view it is difficult to separate oil and gas costs, so the administration recommended looking just at revenues for natural gas. It’s impossible to separate costs, he told the committee, but we know what the gas sold for.

How the tax works in the CS

Dickinson noted that the CS allows use of a royalty settlement agreement in calculating the gross value at the point of production if the Department of Revenue determines that “would improve the efficiency and economy of tax administration” and results in calculations which “are not biased toward understating a producer’s tax liability.”

There are three tax rates in the Finance CS: The base tax is 22.5 percent applied against the production tax value; the progressivity factor is applied against the same tax base at the PPT and is driven by the value of oil after expenses are removed; and the private royalty rate is 5 percent for oil and 1.667 percent for natural gas, both on gross. Dickinson said gross works for the private royalty tax because the royalty owner typically doesn’t have to deal with expenses.

There are five credits: a 5,000 barrel per day equivalent credit, capped at $14 million and non-transferable; a 20 percent transitional investment expenditure credit equal to one-half of current investment for investments in the five years prior to the new tax, the so-called 2 for 1 introduced in the Senate Resources CS; an alternate exploration credit of up to 40 percent under SB 185, which is extended by this legislation; a qualified capital expenditure of 25 percent; and any loss at the end of the year converted to a carry forward credit.

The credits, Dickinson noted, are applicable only against the base PPT. They cannot be used to reduce the progressivity surcharge.

Payments are due monthly on an estimated basis and must be “trued up” for the prior year by March 31 of each year; if any month is estimated at less than 95 percent of the trued up amount, interest is due.

Dickinson noted that the taxpayer can use either 1/12th of annualized or actual monthly costs, and said the hope is that in many situations the state won’t have to look at month-to-month expenses because companies will choose to annualize.

Changes

Dickinson said the administration’s view on the 25 percent credit is that if you’re trying to retain the balance the 20/20 proposal struck, and you raise the tax you also have to raise the credit. He said the administration does not believe the 25 percent credit rate overcomes the 22.5 percent tax rate, and still believes both tax and credit rates should be 20 percent.

Sen. Con Bunde, R-Anchorage, asked about “gaming” possibilities with a tax based on net, rather than gross.

Dickinson said that at today’s prices, about $70, with oil that was very difficult to develop a producer might have costs of $20 a barrel, leaving $50 after costs. At prices of $55 a barrel for oil where the investment has been made and costs are maybe $5 a barrel you also have $50 after costs. Looking at the price driver the two come out about the same.

Dickinson said he thinks what the bill tries to do by recognizing the costs, is to regularize both situations. He said opportunities for “gaming” arise as the price moves around and companies look carefully at costs and whether they can be spent in a month with the highest price. There may be issues around when the invoice went out, when it was paid, etc.

Dickinson said there are some questions of tradeoffs between accuracy and simplicity. Costs of administering may run higher, he said, but if you are aiming at incentives for investment, this is probably a feature the committee wants to look at seriously.

No geographic distinctions

The taxes apply statewide, with no geographic distinctions and with no distinctions between oil and gas, other than the one-third tax rate applied to gas.

There is no separate progressivity for gas, Dickinson said: you look at all activity when calculating progressivity. A price index is calculated by subtracting 45 from the production tax value of taxable oil and gas for the month, divided by the number of barrels of oil equivalent, with 6,000 cubic feet of gas being equivalent to one barrel of oil.

If a producer has only gas, the net profit “wouldn’t come anywhere near the progressivity trigger,” he said. If a producer has mostly oil and a little gas they might pay the progressivity surcharge, but gas would drag the net profit down.





Scheduling issues with House

A House Finance committee substitute for House Bill 488, the production profits tax, has not been introduced.

Finance Co-Chair Mike Chenault, R-Nikiski, said at a House Republican press briefing April 18 that the earliest a House Finance CS would be out would be the end of the week. He said he would like to have the majority of questions answered before the CS is brought out in House Finance to avoid problems with amendments in committee which might not be well understood.

A House Finance hearing on HB 488, scheduled for April 21, has been postponed, so presumably a House Finance CS will not be introduced until the week of April 24.

Chenault said whichever bill crosses to the other side first will be the vehicle used.

House Speaker John Harris, R-Valdez, said the feeling had been that the House would wait for a Senate version because the Senate was smaller and could usually move faster. This is a very large piece of legislation, he said, and in most cases would take two years, but the Legislature has been asked to complete work in about half a session.

The Legislature has hired so-called experts to help, Harris said, but those experts speak to the international situation and don’t always take into account political and business realities, leaving legislators to work their way through all of those issues.

—Kristen Nelson


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