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Gas tax proposal moving Croft says bill incentive to develop gas; Conoco says it’s bad public policy Kristen Nelson Petroleum News
When the House Special Committee on Ways and Means moved a gas reserves tax out of committee Feb. 3, Republican members said they were not moving the bill because they agreed with it, but because it is the subject of a ballot initiative and they wanted the bill to have public debate, something it is more likely to get in the Legislature than as an item on the general ballot.
The bill was introduced in March and heard and held in Ways and Means in April; the committee heard the bill again at a series of meetings in January.
Rep. Eric Croft, D-Anchorage, sponsor of House Bill 223, began a signature drive in August to get a gas reserves tax initiative on the November general ballot, and said in January that more than 40,000 signatures had been gathered. The lieutenant governor’s office has not yet certified the initiative.
Croft was the main proponent of the bill before the committee; ConocoPhillips Alaska offered the only opposition.
The bill goes next to House Oil and Gas, and while its fate is uncertain, the testimony before Ways and Means offers a good primer on an issue which will likely be on the November ballot.
Three cents per year The bill proposes a tax on North Slope gas reserves on fields with known resources of at least a trillion cubic feet unitized before 2002. The proposed annual tax is 3 cents per thousand cubic feet. There is a credit provision for gas owners who commit to ship or sell their gas. The credits can be applied against taxes due only after shipment begins of at least 2 billion cubic feet a day and the credits are good only through 2030.
When Croft introduced the bill to House Ways and Means in April he told the committee that there is “a significant probability that the major gas producers, the leaseholders on the North Slope, are interested in producing other gas fields first.” He said that may be because they can get higher rates of return from gas in other countries. “It also may be that those countries are ... less subtle in how they approach the decision of whether to develop.” He said that countries “unconstrained by ... things like constitutions” can be pretty direct in protecting their sovereign interests. “And I don’t think that the major oil companies have much choice about putting some of these gas fields on line.”
A combination of better rates of return and pressures from other countries “are putting their gas reserves ahead of ours,” he said. Croft: Alaska on the back burner Croft told the committee that growing up in Alaska he’d expected to see a gas line built right after the oil pipeline — in the early 1980s or, worst case, the late 1980s. But it never happened.
The state needs to “do something to assert our sovereignty, to make sure that this is understood to be Alaska’s resource.”
Croft said he wants resource decisions made in Alaska, not in Congress, in the Exxon or BP boardrooms, or by the Sierra Club.
HB 223, he said, is modeled after a Kentucky stranded coal act. West Virginia coal companies bought up Kentucky leases, he said, “not to develop them, but to not have them compete with their other coal ventures.” Kentucky passed a law to tax the coal in the ground. “And that idea appealed to me, to say you build the line or you pay the fine,” he said.
HB 223 would tax gas beginning in 2007 and credit companies once they agree to sell their gas or commit it “to a bona fide project.”
Croft referred to testimony by attorney Spencer Hosie of San Francisco-based Hosie Frost Large & McArthur, to the Legislative Budget and Audit and Senate Resources committees in April (see story in May 8, 2005, issue of Petroleum News), that Alaska leaseholders have an implied duty to produce and market. The defense, he said, is impossibility or “commercial impracticability.”
Croft said that if Exxon wants a higher rate of return than it would get on an Alaska project, “that is not a reason for them not to develop.”
Rep. Ralph Samuels, R-Anchorage, asked Croft about reducing oil production by encouraging companies to sell gas now rather than using it to maintain reservoir pressure, and asked if the duty of the Alaska Oil and Gas Conservation Commission to maximize overall hydrocarbon production was included in the bill.
Croft said that while the commission, along with leaseholders, has a role in determining re-injection at individual fields, the Legislature as the resource holder also has a role. The issue right now is bigger than individual fields, he said, because without a gas pipeline new fields can’t be developed and even fields like Prudhoe Bay are reaching gas-handling capacity.
There is no “specific field-by-field balance” in the bill, he said, “because what this bill wants to do is provide a very strong big hammer to get the gas pipeline going. After the gas pipeline goes, the tax goes away and the AOGCC can balance those field-by-field decisions.”
Croft staffer Mark Gnadt told the committee that the list of gas exempt from the tax came from a letter ExxonMobil wrote to the commission in 1997 detailing how the company would determine how much gas they could market, or the gas available for major gas sales. The wording in the bill, Gnadt said, is an adaptation of ExxonMobil’s wording. ConocoPhillips: producers working with administration At the April hearing the only oil company testimony came from Michael Hurley, ConocoPhillips Alaska’s director of state government relations.
“ConocoPhillips strongly opposes this gas reserves tax,” he told the committee.
ConocoPhillips and the other North Slope producers, he said, have been “diligently working with the administration to hammer out a fiscal contract to provide the certainty to move the project forward,” and said imposition of “this kind of punitive tax” would disrupt the negotiations effort.
He said ConocoPhillips does not believe “you can tax a project into existence,” and said such a tax would not be an incentive, but would increase the uncertainties of an Alaska gas project.
Committee Chair Bruce Weyhrauch, R-Juneau, asked Hurley if leases shouldn’t revert to the state if they are not developed after a period of time. Hurley said Alaska leases do revert to the state if commercial quantities of hydrocarbons are not found within a specified period.
Samuels asked: “If you’re developing the oil ... but you also have paying quantities of gas, is it your interpretation then that it is being developed just because oil’s being developed?”
“Yes,” Hurley replied.
“If you produce the oil and warehouse the gas is that sufficient under the leasehold?” Croft asked the committee. He said he hoped not, because “then literally that gas could be put on hold for decades.”
His bill, Croft said, would provide consequences for holding that gas. Hickel: outside interests holding resources Ways and Means took testimony on the bill again in January.
Former Gov. Walter Hickel told the committee Jan. 11 that outside interests holding onto Alaska resources to avoid competition with resources elsewhere was a concern voiced by Alaska’s delegate to Congress, Bob Bartlett, at the Alaska constitutional convention 50 years ago. The gas reserves tax has been described as “punishing” the producers, Hickel said, and “that’s exactly right.” If you hold onto what may be more than a trillion dollars of someone else’s resources then you must pay a price, he said.
Rep. Norm Rokeberg, R-Anchorage, asked Hickel why attempts to commercialize Alaska North Slope gas by Yukon Pacific Corp., of which Hickel was a founder, had been unsuccessful and if the price of gas in the past didn’t have a major impact on why the state’s gas hasn’t been sold.
Hickel said price had nothing to do with it. The problem, he said, was that Yukon Pacific couldn’t make the owners sell the gas.
Hickel said that Alaska owns the gas, and has to learn to act like an owner state. If Prudhoe Bay had been in Kansas, he said, 100 farmers would own it and their lawyers would be telling the companies to develop it, not waiting for the companies to act. Croft: price for warehousing Croft told the committee Jan. 18 that the bill attempts to set “a price for warehousing Alaska’s gas that is not overly punitive, that has some rational relationship to the revenues we would lose by not having this gas project, but enough of an incentive to move these companies forward.”
While companies committing to a project can get a credit for the tax, the state won’t be paying interest, so the companies “lose the time-value of money,” Croft said. The credit can be applied against 50 percent of tax through 2030, he said, but not until the line is complete and moving gas; a complete line moving gas is also the trigger for terminating the tax.
Since companies don’t receive credit under the bill until they commit to a project or agree to sell their gas, for every year they delay in committing they get less back, and for “every year of delay on this project, that credit drops off that 2030 cliff, and less and less of it do you get back, until three or four years of delay, they’re not getting much back of it at all because of the way interest works.” Value of non-producing leases Rep. Max Gruenberg, D-Anchorage, asked Croft if there was any value to the companies in holding non-producing leases.
There are, Croft said, “significant reasons why Exxon and British Petroleum might want to reserve the gas, even though it’s perfectly economic to produce.”
A lot of a company’s stock value is based on its reserves, Croft told the committee. As companies have consolidated they produce more and more and while “that’s great for your bottom line, it puts pressure on your reserves.” Wall Street, he said, wants to see adequate reserves.
“I don’t want to be Exxon’s reserves,” he said. Part of the reason for the bill, Croft said, is so that Alaska won’t be warehousing gas to support a stock price. The stock price issue also helps explain why ConocoPhillips is more interested in the project than Exxon or BP, he said: “they have more of their reserves here,” compared to ExxonMobil, which is also facing pressures elsewhere in the world to develop its gas. If Indonesia and Russia and the Middle East are better at pressuring gas development, “we will just quite naturally be put at the back of the bus.”
There is also ordinary business competition: Croft said that if Exxon knows it hurts ConocoPhillips if the project is put off two or three years, “then they get to squeeze some of their own competitors at the same time.”
“You start to put those together and there starts to be significant reasons why an Exxon or a British Petroleum would decide, even though it makes money, let’s just not do it for a decade.” Bill requires gas to flow Weyhrauch asked Croft why ConocoPhillips, which has an agreement with the state on gas fiscal terms, should also pay the tax.
Croft said the impact on major leaseholders was addressed through the credit, and an irrefutable start date was required to avoid litigation, so the bill defines the project as under way when there is a pipeline pushing 2 billion cubic feet a day of gas.
A leaseholder’s credit starts when it “makes an irrevocable agreement to sell or a binding transportation agreement,” he said.
Rep. Paul Seaton, R-Homer, asked: If owners don’t make a binding agreement to sell or ship then they get no credit? Croft said that was correct.
Asked by Rokeberg if ConocoPhillips’ agreement with the state, if finalized, would meet the bill’s requirements, Croft said that depends on what the agreement is. If it’s an option for fiscal terms that ConocoPhillips could take “whenever they wanted to, it would not apply here,” he said. That wouldn’t be a project it would just be fiscal terms they could take or leave.
What, Rokeberg asked, if there is no project and a single company, although it wants to sell, is unable to build a project on its own?
“The incentive will remain there until the pipeline is built,” Croft said: “... those that act in the way that we would like them to — those that move towards a project, not just a fiscal regime but a project — will get a credit for that and get all that money back. Those that we have to drag to the table will not get that credit.”
If everything goes well and there is a gas contract signed and approved by the Legislature this year, but the gas tax incentive passes or HB 223 becomes law, Rokeberg asked, would the tax still go into effect in January 2007 even with a contract?
Croft said that was correct. He said “look at it as earnest money.” Even if there is an agreement, and with binding agreements to ship, “we should keep this going so that we have that earnest money and if they’re serious about it, if it’s a serious agreement, if it seriously gets us the gasline that we seriously want then they’ll get that money back, without interest, but they’ll get it back.”
“But we have a system where for every year a delay will cost you and we know it: it’s liquidated damages or earnest money.” Counter point: Griffin for ConocoPhillips When House Ways and Means continued its hearing on HB 223 on Jan. 25 it heard from Jack Griffin, vice president external affairs for ConocoPhillips Alaska, who told the committee: “ConocoPhillips now has a deal with the State of Alaska that it is willing to use as a basis to move forward on the project.”
Agreement in principle was reached Oct. 21, he said, and technical and drafting issues were resolved over the following weeks.
Since the state and ConocoPhillips reached that deal, he said, they “have been trying to negotiate a comprehensive agreement that includes the other major North Slope producers.”
Griffin traced the history of ConocoPhillips’ role: participation in 2001 in a $125 million study to move a gas project forward; a leadership role in seeking reauthorization of the Stranded Gas Development Act; a leadership role in obtaining federal enabling legislation; and a leadership role in advancing an application to the state under the stranded gas act.
He said ConocoPhillips is ready to move to the next step, but “cannot take that step on our own.”
“This project requires economies of scale that we cannot meet by ourselves.”
Concluding stranded gas negotiations between the state and the three producers has been the company’s focus, he said, and the gas reserves tax “undermines those efforts in part by penalizing ConocoPhillips notwithstanding the fact it has taken the very steps that the administration and this Legislature have urged it to take to advance the North Slope gas project.” Company can’t avoid tax Griffin said that “in contrast to testimony previously provided to this committee, there is nothing ConocoPhillips itself can do to avoid imposition of House Bill 223’s new tax, short of surrendering the billions of dollars we have already invested in the development at Prudhoe Bay.”
ConocoPhillips cannot avoid the tax “by selling its gas or by committing its gas to a project under an open season,” he said.
“This tax is automatic and unavoidable. If we started welding steel and laying pipe tomorrow we could not avoid this new tax.”
Griffin said ConocoPhillips believes claims that the tax would be refunded if producers move forward with the project are “inaccurate and misleading.”
ConocoPhillips would likely pay in excess of $200 million a year for the next 10 years, and the tax would not be refunded for 10 to 25 years in the future, with no interest paid. There are limits on the amount of credit that could be applied in a given month, and a cutoff for refunds, he said, the combination of which ensures that “refunds under this bill will only be a fraction of the taxes actually paid.”
Griffin said ConocoPhillips believes HB 223 “reflects bad public policy and we think it’s unfair.”
He said that in addition to the issues he raised, there are “a host of other legal and policy issues ... including serious issues under both the state and federal constitutions.” Impact of unit agreements Samuels asked how the Prudhoe Bay unit agreement would work if ConocoPhillips ever wanted to move forward on its own with a gas project.
Griffin said the unit agreement “is essentially a partnership for the development of the resources, not for the marketing. ... You form a unit agreement to ensure that there isn’t physical or economic waste of the resource, that you maximize the production from a field within a given area.”
There are “no clear provisions” allowing ConocoPhillips to move forward on its own with gas development, Griffin said.
Gas is re-injected now, Samuels said: if ConocoPhillips’ one-third was enough gas to build a pipeline, could the company take that gas and allow BP’s and Exxon’s to stay in the ground?
Griffin said he thought that would be difficult. “I don’t want to say it would be impossible, at this stage, but I think it would be difficult and certainly less than an ideal choice.”
Seaton asked if there would be “a cause of action” with the other owners if ConocoPhillips “was to sell its gas, its third of the gas, and that was then not injected in the ground.” Would that be a violation of the production agreement for Prudhoe Bay, he asked.
“I can’t say that it would be a violation,” Griffin said. But he said he thought that if one owner at Prudhoe Bay “wanted to take its gas without the participation of the other unit owners, we would most likely see the courts asked to resolve differences in interpretations of those agreements.”
Gruenberg asked Griffin how the Prudhoe owners would prevent a project being held up by another owner.
Griffin said that’s the goal of negotiations under the stranded gas act. “We’re all trying to come together on a set of commercial terms that works for all of the major North Slope gas owners.”
But, how, Gruenberg asked, do the owners resolve such issues on an ongoing basis?
Griffin said working interest owners in a unit generally have a common goal “to maximize the production that can be derived economically from a unit” like Prudhoe Bay, and have “complex agreements that help govern our relationships.” The issue of sitting on the gas Weyhrauch asked Griffin why he believed HB 223 was bad public policy.
Griffin said ConocoPhillips “has all of the incentives necessary to move forward on a gas project.”
The state already provided the right incentive to move the project forward with the stranded gas development act, he said. “That’s the right incentive.”
A tax which is imposed “as a weapon to force private parties to expend billions of dollars on the state’s behalf without regard to whether the investment makes sense — and there’s nothing in the bill that would require that the investment actually make sense — is a novel and even unprecedented use of a state taxing authority,” he said.
Weyhrauch noted that one of the retorts to that is that the oil companies are using the gas as part of corporate portfolios “to show stockholders that the price of the stock is actually valid because you’re sitting on this large resource, and that it’s unfair (for Alaska) to serve as a reserve for the benefit of the corporation.”
“There is no benefit, in our view, to a corporation to quote sit end quote on Prudhoe Bay gas,” Griffin said.
A corporation cannot count gas as part of its reserves base for Securities and Exchange Commission reporting, or reporting to shareholders and potential shareholders, “until you’ve authorized the development of the project necessary to move that gas to market. So it does absolutely no good to sit on the gas and not move forward with it,” he said.
Seaton asked whether the Legislature would find any North Slope gas reserves listed for any of the companies.
Griffin said he couldn’t speak for any company other than ConocoPhillips. “I can give you our view and our pretty clear understanding of what the SEC rules require. And our understanding is, until you’re authorized the expenditures necessary to make those reserves marketable, they don’t become reserves for reporting purposes.
“They’re known resources, but they’re not reserves,” Griffin said, and it’s reserves that the market and shareholders look at. If gas had been sold in the 1980s Rokeberg asked Griffin if he would provide state and federal constitutional issues related to HB 223, and also asked Griffin what he thought would have happened if North Slope gas had been sold to Yukon Pacific and a line had been in production in 1994.
Griffin said that in the decades following the discovery of oil at Prudhoe Bay natural gas prices couldn’t support the cost of transportation infrastructure to market once those markets were deregulated in the 1980s.
He said “the state would be a far, far poorer place today had we been foolish enough to build a gas project back then and essentially given away our gas for less than the cost of transporting it.”
The state would have lost the value of the gas, he said, and “we would have also lost the value of approximately 3 billion barrels of oil at Prudhoe Bay that we’ve been able to recover as a consequence of re-injecting that gas and making beneficial use of the gas at Prudhoe Bay.” Bill moves from committee On Feb. 3 House Ways and Means, without objection, moved HB 223 out of committee.
The bill is also the subject of an initiative and Samuels said that while he has voted for initiatives, he is a believer in the legislative process: “despite all the rhetoric on both sides of the aisle, nothing ever really swings too far one way or another, because it is so hard to get something through the process,” he said.
Initiatives circumvent the legislative process, he said, and while the legislative process is frustrating, it “brings forward all of the experts, all of the testimony, all of the political maneuvering that make it so difficult” to get some things through.
“It also brings all points of view to the table,” he said.
Samuels thanked ConocoPhillips for its testimony, and said while he could guess what ExxonMobil and BP think about the bill, he would have liked to have heard it from them.
“If we don’t have the debate in the legislative process, then we’ve lost a key element of having the legislative process,” he said.
Samuels said if the bill didn’t move, there won’t be a debate: “and then we’ll be stuck in what I consider the worst of all worlds — no debate in the legislative process, the initiative process will move forward, it will be on the ballot, and very little debate takes place in the public arena and we’re making a huge public policy decision, worth a billion dollars a year” without debate.
Weyhrauch said the committee has “bent over backwards to take public testimony on these measures ... there’s been lots of opportunity for that kind of public testimony.”
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