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ISER on PPT: Long-term focus needed Production, revenue in 10 or 20 years more crucial than revenues next year, says institute’s Berman Kristen Nelson Petroleum News
Bill incentives in Alaska’s proposed production profits tax, the PPT, actually work to bring in new investment? And will that investment result in increased oil and gas production, hence increased revenues?
Those long-term questions should be the focus in debates over the PPT, said Matthew Berman of the University of Alaska Institute of Social and Economic Research in an April paper: “Changing Alaska’s oil and gas production taxes: issues and consequences.”
Revenue projections represent an educated guess, he said: the long-term results of a change in the state’s oil tax mechanism should be the focus — oil and gas production and revenues in 10 or 20 years — rather than revenues next year.
The PPT is an improvement over the current production tax, he said, because under the PPT “the state would better share risk with oil companies and cause fewer adverse effects per dollar of revenue collected.”
Will there be disputes and litigation as a result of a new tax system? Expect it, Berman said, noting that “the state has weathered these before.”
He said the PPT “should not be viewed as an opportunity to increase the state’s take from its oil and gas,” because oil prices are more likely to fall from current levels than to rise in the long run, “meaning that the state take from the PPT may be no more, and possibly less, than it is now.” He said based on Alaska’s experience with its last major oil tax overhaul, in 1981, “it is impossible to know exactly how much revenue will change when the basis for taxation shifts. The PPT will not solve the long-term problem of the fiscal gap caused by declining oil production. No oil tax can,” he said.
State’s oil and gas taxation roles The state collects tax from the oil and gas industry both as a resource owner — collecting payments such as royalties — and as a sovereign, collecting production, property and income taxes. Royalties are part of the lease terms, and can only be changed by mutual consent, Berman said, while the state has the right under its constitution to change its tax regime at any time.
An oil and gas field that is marginal will earn only enough to pay for costs of exploration and production and a competitive return to investors and in theory, government can appropriate any surplus, the so-called economic rent.
“In practice, however, every possible way to collect the economic rent through taxes or lease payments has some adverse effects,” he said, some of those with “significant unintended consequences.”
Big oil and gas tax questions The size of government take is a big issue, but Berman said “the way that the government collects its revenue also matters. All fiscal instruments create some negative incentives for industry investments. But for any given government take, some instruments have bigger effects than others.”
Royalties and production taxes are the largest sources of the state’s petroleum revenues, and are the bulk of the state’s recurring oil and gas revenues. Berman said that during the 1980s and 1990s “the state take was nearly constant at about 30 percent of wellhead value in recurring revenues and 35-40 percent, considering all petroleum revenues,” while state take has been declining since the late 1990s, “due primarily to the falling ELF in the production tax.”
State take remained so constant “because most revenues came from royalties and production taxes that were assessed as a fixed percent of wellhead value.”
The PPT would be a “significant” change, Berman said. Government take would be higher at high oil prices, but the downside is that government take would be lower than it is today at low oil prices and “oil prices would have to remain at today’s historical high levels to keep the state take from a 20 percent PPT as high as it was during the 1980s and early 1990s.”
Historically, prices have been much lower than they are today, he said: “In only nine out of the past 45 years has the real wellhead price averaged more than $25 per barrel, which is the point at which PPT would collect more revenue than the current tax. At real world oil prices below $20, the state would lose money.”
There are two main ways in which how government takes it share impacts business decisions. Taxes “that defer collection of revenues allow companies to recovery investment costs faster, increasing the rate of return.” And “taxes and lease payments assessed without taking costs or profit into consideration may make some marginal fields uneconomic to develop that could be profitably developed without the tax or royalty.”
Berman said Alaska’s current system “ranks poorly on both criteria. The PPT, with a tax credit for capital expenses and cash flow deductions for capital and operating costs, fares much better.”
Sharing risk The oil business is risky, from making an exploration find, to having that find be large enough to be commercial, to fluctuating prices and changing government tax regimes, Berman said. “The progressivity of the fiscal regime relates to the degree to which the government shares these risks with the developer.” A progressive fiscal system collects a larger share of net income as income increases while a regressive system collects a larger share as income declines. Regressive tax regimes stabilize government revenues but make industry profits more volatile, he said, increasing “political risk as well as financial risk.”
“On the other hand, progressive measures are often more complex and challenging to administer and modify.” Berman said there is “a tradeoff between risk, and stability or simplicity.”
Alaska has traditionally relied on a regressive fiscal system and the PPT would replace about half of what could be called somewhat regressive revenues with neutral or progressive revenues, he said.
Berman compared three investments: exploration; heavy oil development; and investment to prolong field life. He found state revenues were nearly identical under existing taxes and a 20 percent PPT, but for all three projects “the 20 percent tax credit greatly reduces the after-tax investment cost,” with effects most beneficial for exploration and development. “These are investments at earlier stages of the life cycle that have the biggest effects on future production, industry profits and state revenues.”
Looking at the exploration example, Berman said the PPT could reduce the minimum economic field size, which is high in Alaska because of remoteness and lack of infrastructure, by one-third: from 150 million barrels to 100 million barrels.
“A big reason that the returns to industry are much higher under the PPT is that the tax credit and deduction for field investments result in a deferral of state tax payments,” he said.
“One can usually assume that higher taxes discourage investment. However, the 20 (percent) proposed PPT with its investment tax credit and deductible capital costs actually generate a higher rate of return in this example ... than investors would realize with a zero production tax,” Berman said.
Regressive taxes may have made sense for Alaska 30 years ago when North Slope oil was being developed and the state had few financial assets and a lot of obligations, he said. “Today, however, with a mature oil industry and tens of billions of dollars of assets in the Permanent Fund and Constitutional Budget Reserve, the state can much better afford to share the risks with the industry.”
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