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Providing coverage of Alaska and northern Canada's oil and gas industry
January 2010

Vol. 15, No. 5 Week of January 31, 2010

Finding the sweet spot for oil and gas

Conference speakers review Alaska’s current situation in worldwide competition for oil and gas industry investment dollars

Alan Bailey

Petroleum News

In the “oh yes it is, oh no it isn’t” debate about the effectiveness of Alaska’s ACES oil production tax, it’s easy to lose sight of the many factors that go into an oil company’s decision over whether to invest new capital in, say North Slope exploration, vs. drilling some wells elsewhere in the world. And in the Alaska Support Industry Alliance Meet Alaska energy conference on Jan. 22 speakers added their perspectives to the debate, supported by a bewildering array of information ranging from Alaska jobs data to industry assessments of the regulatory climate.

Scott Goldsmith, professor of economics with the University of Alaska Anchorage Institute of Social and Economic Research, talked about state oil and gas production tax policy in the context of the importance of the oil and gas industry to the state.

Determining a tax policy should not be a zero sum game, with both the state and the oil industry trying to secure as much as possible from a fixed production and revenue pool, Goldsmith told the conference attendees.

“There’s some level of taxation and other fiscal policy that gets us to the sweet spot, that accommodation of production, employment and revenue that maximizes benefit to the state, not just today, but for the foreseeable future,” Goldsmith said, adding that no one knows yet where that sweet spot lies.

The size of the total oil and gas pie is not fixed — there is some set of tax rates that will maximize the size of the benefit pie for the state, taking into account the impact of those rates on future production levels, he said.

Production and employment

Goldsmith presented some perplexing data showing that, while Alaska oil production has continuously declined over the past 20 years, employment in the state has continuously increased.

“Does this mean that the economy has reached a takeoff point in its development, resulting in stable development without petroleum?” Goldsmith conjectured. “Have we been successful in developing a diversified economy using revenues from oil?”

The answer to those questions is “no,” he said.

But there has been some oil industry job growth in the last decade as a consequence of oil infrastructure upgrades, development of new production from known resources and exploring for new reserves, he said.

“These categories of employment growth have benefited from the value of (oil) production remaining steady, even as production has declined,” Goldsmith said, presumably referring to the compensating effect of the rising price of oil. “In 2008 we enjoyed the second highest year ever for the value of production — $26 billion.”

And the high value of the oil production also contributed to increased numbers of state and local government jobs, he said.

But oil industry employment levels remained fairly static in the previous decade, while the total of jobs in other industries such as transportation, forestry, mining, tourism and fishing has not changed much over the past 20 years, he said. In fact Goldsmith attributed much job growth during the last two decades, in part, to an expansion in federal spending in Alaska, especially since 1990, and in part to the infilling of support services such as health care in the state, thanks to the size and stability of the oil industry.

Alaska has been catching up with the rest of the United States in the provision of services for local businesses and households, Goldsmith said.

Future growth

However, federal spending is unlikely to continue to grow at its recent rate, while the infilling of support services “has pretty much run its course,” he said. That leaves the petroleum industry as the key to future economic growth in Alaska. And although the remaining oil and gas resource base in the state is huge, perhaps sustainable for another 50 years, the easy oil has gone. With increasing production and transportation costs, and with substantial amounts of future oil and gas likely to come from the federal offshore, the state’s revenue share will drop, he said.

“In order to be successful, the state will need to play the game with more intelligence and skill, and less emotion, than we have in the past,” Goldsmith said. “And that game, of course, is to get the greatest long-term benefit for the state … from the petroleum resources.”

The state should not put petroleum revenues into speculative projects, rather than allowing the money to be plowed back into the petroleum industry, “a proven winner with a 50-year history of success,” Goldsmith said.

But maximizing benefits to the state involves finding that “sweet spot” for fiscal policy, where encouragement for additional future production is balanced with the state’s revenue needs.

And the state should devote more effort to finding that spot, perhaps by maintaining an inventory of potential petroleum investments, together with their likely sensitivities to different tax rates, Goldsmith said.

Trust needed

Fred McMahon, vice president of research, international, in the Fraser Institute, told the conference that Alaska’s first priority in attracting new oil industry investment should be to build certainty and trust within the oil industry, particularly with respect to regulation and the tax code.

“The first thing Alaska has to do to regain its competitiveness and become globally competitive is build certainty,” McMahon said. “What Alaska has to do is regain the trust of business.”

This doesn’t mean having regulation that is inappropriately light; it means having regulation that is predictable and sensible, he said.

McMahon presented the results of the Fraser Institute’s latest survey of oil industry views of various jurisdictions around the world. The survey, conducted annually, involves asking oil company executives to rate each jurisdiction on a series of 14 policy factors such as the commercial environment and the regulatory climate, asking each executive to comment on the extent to which each policy factor encourages industry investment.

Jurisdiction league

The institute then draws up a series of jurisdiction league tables for the individual factors and for a composite of all factors, enabling the jurisdictions to be ranked and then grouped into quintiles, or fifths, with the first quintile containing those jurisdictions that are the most appealing for investment and the fifth quintile containing the least attractive jurisdictions.

The league tables separately rank onshore and offshore Alaska, recognizing the differences in jurisdiction between these two regions — state taxation applies to onshore Alaska, while federal jurisdiction and tax codes apply to the outer continental shelf.

“In 2009 the survey was answered by 577 executives worldwide representing more than 275 companies,” McMahon said. “One hundred and forty-three jurisdictions were ranked vs. 81 in the previous year.”

The league table for the composite of all factors places both Alaska regions in the second quintile — globally, a pretty good rating, but a rating well behind most other U.S. states, most of these being in the top quintile. Only California and Colorado rank below Alaska in the United States.

“Your competition, frankly, here is not bad-news drilling in the Democratic Republic of the Congo. Your competition is from the United States,” McMahon told the conference attendees.

And McMahon cautioned about Alberta’s ranking, which has declined significantly in the recent past, causing the Canadian province to drop into the third quintile.

“To some extent this shows you what can happen if a jurisdiction comes to rely on oil and gas and thinks that it basically inherited the family mansion and doesn’t have to worry about being competitive anymore,” McMahon said. “And I think to some extent that’s what’s been going on here in Alaska.”

Europe ahead

Much of Europe ranks in the second quintile, along with Alaska, but most European nations come ahead of Alaska within the quintile. And British Columbia ranks ahead of Alaska, despite issues in that province around Native land claims, “eco-extremism” and disputes between the provincial and national governments.

The league tables for individual policy factors indicate that oil industry executives view Alaska has having relatively low levels of geopolitical risk. But the state comes in at around the middle of the pack when it comes to fiscal terms for the oil industry. And Alaska drops well below the middle of the table when it comes to environmental regulation. In fact, onshore Alaska rates third from bottom of this particular table, even some way below environmentally conscious Norway.

“This isn’t because Norway’s regulations are weak. They aren’t. This is because Alaska’s are uncertain and difficult,” McMahon said. “This means that while they may not protect the environment as well as Norway’s do, they will discourage investment more, because when somebody goes to Norway they know what’s going on.”

Alaska investments

But oil and gas companies will come to the places where the resources are located and, so, they will come to Alaska, McMahon said. The question is whether Alaska is reaping the full benefit from its resources.

“What our research shows is that global perception … will drive away investment,” McMahon said.

It is possible to make the regulatory environment more conducive to oil and gas development without sacrificing environmental protection — countries like Norway have demonstrated that view, he said.

“One of the things that the most gung-ho oil executive and sincere environmentalist should agree on is a certain, clear, predictable regulatory environment,” McMahon said. “… While the industry prefers free-market economies, the most important things are clarity, certainty and efficiency, and according to our survey Alaska can improve all of these.”






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