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February 2006

Vol. 11, No. 8 Week of February 19, 2006

Legislators quiz van Meurs on PPT plan

The administration’s presentation to joint House-Senate Finance committees drew a variety of questions on proposed oil tax

Kristen Nelson

Petroleum News

Legislators had a number of questions following the Feb. 1 production profit sharing tax presentation by Pedro van Meurs, a consultant to the state, and Roger Marks of the Alaska Department of Revenue.

Van Meurs and Marks presented an overview of the proposal, and analysis of revenues the state would get at a range of tax rates requested by legislators (see story in Feb. 12 issue of Petroleum News).

The production profit sharing tax, or PPT as it is being called, would tax corporate-wide profits from Alaska oil production. It would replace the state’s present production severance tax and the economic limit factor used to determine field-by-field tax rates.

Sen. Con Bunde, R-Anchorage, asked if companies wouldn’t be able to hide their profits using clever accountants.

Van Meurs said there was that potential. But, he said, other jurisdictions such as Norway and Alberta use profit sharing systems, and “there is no widespread international experience to indicate that governments really get cheated, say, out of massive profits.”

But, he said, the tax will have to be set up so that it is “sufficiently transparent” and the ground rules are clear. Alaska already has experience with net profit sharing leases, and there are regulations guiding how profits are calculated today, van Meurs said. “So it is not something that would be completely new for Alaska.”

He said he has seen “a number of cases where governments and companies disagree about the deductions.”

And it can be simplified: some countries use the joint venture billing system that companies use among themselves.

He said he agreed with Bunde that if Alaska goes forward with this kind of a tax, “a PPT law needs to include a significant section that would set out the ground rules for precisely how these profits are being determined.”

Definitions of qualified expenditures

Rep. Kevin Meyer, R-Anchorage, co-chair of House Finance, asked about the distinction between a tax credit for exploration and re-investment in an existing field.

Van Meurs said the law would have to define qualified capital expenditures, “what qualifies and what doesn’t qualify.” In the economics run for the presentation he said the assumption was that a tax credit covered all exploration expenditures, including dry holes and geophysical.

There are tax credits on all capital investment, including all re-investment. The tax credit “is a universal mechanism at the corporate level,” van Meurs said.

Marks said since capital costs get a credit and operating costs don’t, there appears to be an incentive in the proposal to shift expenditures from operating to capital. But, he said, “what’s capital and what’s operating is going to be defined by federal terms for the federal income taxation.” And federal taxation provides an incentive to make things operating rather than capital, “because if they’re operating you can deduct it right away, where with capital you have to depreciate it.”

The federal tax code, Marks said, “actually is a self-enforcing mechanism to ... hinder that incentive to shift costs between operating and capital.”

Sen. Gene Therriault, R-North Pole, asked if van Meurs thought a bill should differentiate between frontier exploration and replacing piping or facilities in existing fields. Replacing a compressor in an existing field has very little risk, Therriault said, compared to the risk of exploring for a new Alpine field.

Van Meurs agreed there are different risks for different kinds of capital expenditures. He said the administration has tried to take a broader view, looking at an investment as a new investor would: “the whole exploration program and a possible investment in development of the field as a totality, how does that look” in comparison with other opportunities worldwide.

The fact that there is a tax credit for subsequent capital investment “makes the exploration considerably more attractive,” he said. “So that is why our results show that this introduction of the PPT and the tax credit, even if it is the same rate for exploration capital expenditures and equipment expenditures, exploration in general becomes far more attractive.”

The heavy oil issue

Therriault asked about the proposal that heavy oil would have some incentive in the bill, perhaps a different level of credit.

Van Meurs said that is something that is being studied; “we have not reached a firm conclusion on it.” He agreed with Therriault that the higher costs and lower revenues from heavy oil “would already result in a lower level of profitability, by definition,” automatically reducing profits and hence PPT receipts.

He said that many nations “have come to the conclusion that heavy oils need further special fiscal incentives,” including Alberta, Saskatchewan, Venezuela and Columbia.

Van Meurs said he couldn’t say what might be proposed for heavy oil, but he said in principle Therriault was correct: “The PPT system automatically corrects already for the higher cost and the lower revenues.”

Small companies favored

Sen. Hollis French, D-Anchorage, asked van Meurs what would happen under the proposed tax change if the three majors are no longer active in Alaska a few years in the future.

Van Meurs said the proposal favors smaller companies, as do some other jurisdictions such as Alberta which typically rebates a large proportion of the royalty for small producers — a strong policy to encourage smaller companies.

“And we took some inspiration from those ideas.”

Because of the preference for smaller companies, van Meurs said the legislation needs to include protection to ensure that a company doesn’t voluntarily fracture into smaller companies in order to benefit from the deduction. He said Alberta manages that very well: it is “not too difficult to have particular approval procedures for new entrants to make sure that it is not done in order to essentially evade taxation.”

Van Meurs said he agreed with French that as an oil province matures smaller companies typically take on an increasingly larger role, such as in Alberta where conventional oil is practically all produced by smaller companies while larger companies are working big projects, requiring big investments, to develop the oil sands.

He noted that the North Slope producers have said in public forums that they see a long future in Alaska. What the administration hopes, he said, is that as a result of the PPT and the gas line there will be “more enthusiasm for the major oil companies to continue their strong presence in Alaska.” He said the state needs both the major companies and “aggressive new smaller entrants that start to take up the smaller pieces and start to develop the same kind of wealth in Alaska that has been developed in, say, Texas or in Oklahoma or in Alberta.”

And the legislation would provide an incentive to the majors to see if they can sell off specific pieces to smaller companies who could take on smaller tasks. That, he said, would be a good development. “This legislation will encourage that.”

Smaller fields encouraged

Rep. Mike Kelly, R-Fairbanks, asked about the coupling of PPT systems worldwide to investment credits, and van Meurs said most PPT systems worldwide are production sharing style contracts set up on a field-by-field basis, “so the tax credits cannot really be used outside; it is field specific.”

He said other jurisdictions have other ways to encourage smaller fields: Norway has what it calls “uplift” permitting deduction of more than 100 percent of capital costs. In Australia there is no tax due until a particular level of production is reached.

Developed countries have features to make their tax systems more attractive for marginal fields and small companies.

The fact that tax credits are tradable will be important to new entrants. “Since Alaska has a specific policy of actually attracting the new companies, the tradable tax credits are a far more efficient way of doing that.”

The tradable credits, he said, are “a rather specific application of tax credit that is quite unique from that perspective, but it was proposed in order to specifically help the smaller explorers and encourage new investors to come to Alaska.”

Relationship to gas negotiations

Rep. Bruce Weyhrauch, R-Juneau, asked Commissioner Corbus about the relationship of the oil tax change to gas pipeline negotiations: “If the Legislature adopts a profit sharing production tax at a rate above 25 percent or below 17.5 percent ... is the PPT still conducive to proceeding with gas pipeline negotiations?”

Corbus said he didn’t know the answer to the question, but said the administration does intend that whatever oil tax change the Legislature adopts “will be included in the gas pipeline negotiations.”

Weyhrauch asked if the agreement the administration has with one of the North Slope producers (ConocoPhillips) could be lost if the state changes from ELF to PPT.

“It’s possible,” Corbus said. “The one company that has agreed to the gas pipeline agreement has not agreed on the PPT.”

How attractive?

Meyer asked about van Meurs’ comparisons of investment attractiveness, noting that federal waters in Gulf of Mexico are the most attractive on the list of investment possibilities (van Meurs had used jurisdictions where companies investing in Alaska also invest).

The U.S. Gulf is a very attractive area for exploration and production, van Meurs said. “Alaska will not be able to compete fiscally with that high level of attraction.” What the state is trying to achieve, he said, “is the art of the possible ... how can we make Alaska more attractive?”

“How can we create a system in place that attracts new investors but that is still within the reasonableness of what Alaska really needs to earn from its resources? The federal government, of course, has a wide range of other possible revenue sources,” he said.

The $1 trillion pie

Sen. Ben Stevens, R-Anchorage, president of the Senate, asked about a summary chart that Marks had presented, showing cumulative revenues over a 45-year period.

Marks said the chart showed the gross: “the West Coast price times the volume.”

The chart was divided to show the various costs of production and the take by the producers, the state and the federal government.

In terms of taxation, Marks said the PPT would be deductible for federal income taxes, so PPT is an increase (over current production tax), but 35 percent of the PPT is a deduction for federal income taxes, so the federal government picks up 35 percent of the PPT bill and the producers pick up the other 65 percent, after tax.

The trillion dollars over 45 years includes some $200 billion in federal taxes, Marks said.

Stevens asked legislators how much money Alaska gets from the federal government and was told about $3 billion a year.

“I’m pontificating here,” Stevens said, noting that Alaska has been called “a state that takes more than we supply,” while the figures assembled for a PPT tax show “that we have the potential to contribute $200 billion and we get labeled for being on the take for taking half of (that) back.”

Marks said a lot of the $200 million “is simply attributable to the magic of compound inflation at 2 percent over 45 years,” but Stevens recommended the chart be used to promote the state and to increase awareness on a national level “about the fact that we are net providers to the federal treasury.”






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