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Vol. 18, No. 7 Week of February 17, 2013
Providing coverage of Alaska and northern Canada's oil and gas industry

Alaska’s ELF war

Oil companies continue to fight a controversial 2005 tax change that cost them big

Wesley Loy

For Petroleum News

Back in 2005, then-Gov. Frank Murkowski rankled the Alaska oil industry with an announcement that several satellite oil fields would be “aggregated” with the main Prudhoe Bay field for purposes of production taxes.

The effect was to greatly increase the taxes paid on oil produced from the satellites.

The decision by Alaska’s Department of Revenue drew serious industry grumbling and political heat for Murkowski. But he stood firm and the unhappy oil producers got over it.

Right?

Not exactly. Turns out a quiet battle over the tax hike has been simmering ever since. And it’s far from over.

During a Feb. 7 legislative hearing, a top oil and gas lawyer for the state offered a status report on the conflict, saying several hundred million dollars in tax revenue is at stake.

Recently, he said, an administrative law judge rendered a favorable decision for the Department of Revenue.

Now the oil companies are appealing that decision in state Superior Court.

The companies involved

The companies challenging the 2005 tax hike include Chevron, ConocoPhillips, ExxonMobil and Forest Oil.

The firms are working interest owners in certain “participating areas” of the Prudhoe Bay unit, the most productive unit on Alaska’s North Slope.

The participating areas, or satellite fields, include Aurora, Borealis, Midnight Sun, Orion, Polaris and Point McIntyre.

All the satellites are strongly integrated with the main Prudhoe Bay field, with all but Point McIntyre having no production facilities of their own.

For many years, oil produced from these satellite fields enjoyed a very low tax rate, due to the application of a tax break calculation known as the “economic limit factor,” or ELF.

“Very broadly, the purpose of the ELF was to prevent fields from becoming uneconomic due to an excessive rate of taxation,” said the decision dated Oct. 13, 2012, from the Alaska Office of Administrative Hearings. “The ELF was intended to scale the tax rate downward as the field approached its economic limit.”

Tax break removed

Over time, officials in the Department of Revenue began to have misgivings about the application of ELF to the Prudhoe satellites.

By the end of 2004, the tax rate being applied in the satellites was “miniscule” in comparison to the rate applied to production from the main Prudhoe Bay field, the administrative law judge’s decision said. While Prudhoe production was taxed at an effective rate of about 12.5 percent, production from the satellites was taxed at less than half of 1 percent.

Department of Revenue officials saw how the satellites shared Prudhoe production facilities, and how the satellite oil was “commingled without reliable metering,” the judge’s decision said.

Further, the officials noted a “production-shifting technique” whereby Prudhoe wells were being choked back, with production increased from satellite wells. This was done to help manage problematic rates of natural gas coming out of the older Prudhoe wells. But the effect was to replace high-tax oil with low-tax oil, the administrative law judge’s decision said.

On Jan. 12, 2005, the Department of Revenue issued a decision informing the oil companies that the satellites would be aggregated for ELF purposes. In other words, a major tax increase.

Gov. Murkowski announced the surprise tax hike the same day in his State of the State address.

A few days later, at a major oil industry conference in Anchorage, Murkowski received a chilly reception. He said after he felt “a little like a pork chop being thrown around the wolf cage.”

Judge’s decision

The central issue before the administrative law judge, Christopher Kennedy, was whether the Department of Revenue’s aggregation action constituted a regulation.

“If so, it would be invalid because it was adopted without following the procedures that Alaska law requires to create a binding regulation,” Kennedy wrote. Such procedures would include advance public notice and opportunity for public comment.

Kennedy, in his 20-page decision, held that Revenue’s action was not a regulation, and was proper.

The tax period at issue covers only about a year, from Feb. 1, 2005, to March 31, 2006. That’s because the ELF statute was repealed effective April 1, 2006, as part of state tax reform.

But despite the short period, the production tax revenue at issue is huge, in the hundreds of millions of dollars, Martin Schultz, supervisor of the Alaska Department of Law’s Oil, Gas and Mining Section, told state legislators in the Feb. 7 hearing.



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