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Vol. 12, No. 36 Week of September 09, 2007
Providing coverage of Alaska and northern Canada's oil and gas industry

Oil taxes revisited

Hybrid net-gross tax would raise more than PPT actual, less than PPT proposed

Kristen Nelson

Petroleum News

Gov. Sarah Palin wants the Alaska Legislature to change the state’s oil tax system from a tax on oil company profits — a net tax — to a hybrid tax, part net and part gross. The goal is to increase revenues from what the governor called the state’s “very, very valuable non-renewable resource.” That resource is being sold “at a premium,” Palin said Sept. 4 at an introduction of the administration’s new tax proposal. “And we’d love to receive appropriate value for our oil: We need a clear and equitable share.”

Why a change now, barely a year after passage of a new production tax in August 2006?

“PPT isn’t working as promised,” the governor said, introducing a proposal called “Alaska’s clear and equitable share,” the ACES plan.

PPT, the state’s existing petroleum profits tax, was enacted under the previous administration. It is a tax on profits, a net tax, and replaced the state’s previous production tax which was a tax on the gross.

The fiscal note prepared for the PPT bill projected state revenues of more than $2 billion at a $60 oil price. The Department of Revenue is now projecting a shortfall of $800 million from that projection for fiscal year 2008, with estimated revenues at $60 oil of $1.3 billion.

Revenues expected under PPT are more than those projected under the previous production tax, with its economic limit factor or ELF, estimated to bring in less than $1 billion with $60 oil. PPT, however, is not performing as expected due to higher costs than expected (see “PPT special session set for Oct.18; new oil tax not bringing in what projected, says governor,” in Aug. 12 issue of Petroleum News).

Three principles for new tax

The governor said the ACES plan is based on three principles: “First, the tax must return a fair level of revenue to the state; the tax must not be punitive but rather create an attractive investment environment to ensure new exploration and future development; and the tax should be simple and transparent enough that we don’t get gamed by oil companies.”

The administration looked at both net and gross taxes, looking for “something that was simple and transparent,” but determined that neither net nor gross “is really simple and there are tradeoffs between the two.”

The governor opposed a net tax when she campaigned for office, but said when economists and experts studied how to change the tax system, “I insisted that the numbers speak for themselves.”

A pure gross tax is easier to administer, she said, because “audit requirements and litigation risks are lower.” The downside of a gross tax, however, is that state revenues dip when oil prices dip. A gross tax also doesn’t create a positive investment climate because a higher tax rate to bring more revenue into the state under a gross tax has “more of a detrimental effect on the economics of certain valuable North Slope fields” that the state needs to have developed, she said.

The special session to consider the proposal starts Oct. 18 and Commissioner of Revenue Pat Galvin said the administration wants to have a draft bill out early in October so discussions with legislators can begin before the special session starts.

The governor had wanted the special session on the state’s road system so more Alaskans could participate, but legislators wanted to meet in Juneau. Palin said she hopes legislators will hold committee hearings on the road system, and said the plan for the legislative session, like the tax proposal, was a hybrid.

Revenue raises concerns

The revenue aspect of the new proposal raised investment-related concerns.

Paul Laird, general manager of the Alaska Support Industry Alliance, said the organization is concerned about the impact of the proposal on jobs.

“We have not had time to fully assess the proposal yet,” he said in a Sept. 5 e-mail, “however, the Alliance opposes any tax increase that robs Alaskans and Alaska businesses of long-term jobs, business opportunities and investments only to feed state government’s insatiable appetite for spending. ‘ACES’ appears to be nothing more than another tax increase that’s dressed up in a cute acronym and would come at the expense of private sector growth,” Laird said.

Chevron also has concerns; in a statement relayed by spokeswoman Roxanne Sinz the company said: “The decision that Alaskans must make is a tradeoff between increased short-term revenue for the state and the long-term health of the upstream energy industry in Alaska. A constantly changing and increasing tax regime is a real threat to the stability of the industry and state revenue in the long run,” the company said.

ConocoPhillips Alaska is concerned about the effect of the proposal on investment.

“We agree with the governor’s approach to stay with a PPT-based tax structure, however, we are concerned that the tax rates proposed will make every single project look less attractive for us to re-invest,” Kevin Mitchell, the company’s vice president of finance and administration, said in a statement.

BP spokesman Steve Rinehart told Petroleum News that BP hadn’t yet had a chance to really look at the proposal and said the company will be taking “a very close look at how different aspects of this will play out” as more information becomes available.

“What’s clear,” he said, “is they intend to collect an additional $700 million.”

“Taxes and investment have to be part of the same conversation,” Rinehart said. He said that is “… a very important conversation,” because “… investment is what will keep Alaska’s oil fields alive.” North Slope production will go into “a steep decline” “without huge and sustained investment,” he said.

Rinehart said the message BP hopes will connect with people is that “production decline is our common enemy.”

Relative tax level

The tax level proposed in ACES would make Alaska “the highest cost place to operate in North America — significantly more expensive than operating in the Gulf of Mexico” or in Alberta, Rinehart said. Alaska is not an average place to do business: “Our resources are expensive to get out of the ground” and will become more expensive as heavy oil is developed. Distance from market is also an issue, he said: The oil has to be sent through an 800-mile pipeline and then shipped thousands of miles to markets on the West Coast.

“This is all about the future,” Rinehart said. “These oil fields will last a long time but they’ll require a lot of investment in a climate that encourages investment.”

Galvin said the state has “to acknowledge that each time we raise our taxes we have a bigger bite of the amount of revenue that comes into a company.” While comparisons to other governments depend somewhat on which economist you ask, at $60 oil Alaska under ACES would be at 68 percent of marginal government take, Galvin said.

ACES would place Alaska “significantly higher” than its peers, “other royalty and tax governments,” he said.

“But that’s a reflection of the prospectivity that Alaska provides, the stability of the government and other things that are going to weigh in our favor that allow us to have a higher take and still attract that investment.”

He said the administration believes that with ACES “we are providing that aggressive level of revenue generation while still balancing the investment protection.”

AOGA: Third tax increase

Marilyn Crockett, executive director of the Alaska Oil and Gas Association, the industry’s trade association, said “Alaska already has the highest oil and gas tax regime in North America. The new proposal moves Alaska further up the ladder in this respect, seriously jeopardizing the competitive position of the State for important industry dollars.”

Crockett told Petroleum News Sept. 6 that AOGA believes “PPT is working as designed, given that it resulted in an additional $1 billion in new taxes last year and industry continued to invest in Alaska operations.”

She also said the governor’s proposal would be “the third increase in taxes in three years levied against the oil industry.”

“Two years ago, by administrative action, an additional $150 million in taxes were levied against the industry,” Crockett said, referring to action by former Gov. Frank Murkowski that changed how the ELF production tax was administered.

PPT raised taxes a year ago, she said. “Now industry is facing an additional $700 million in new taxes. All told, industry will have been subject to an additional $2 billion in new taxes in just three years, and at a time when increased investment is absolutely necessary to stem the annual 6 percent decline in production. Increasing taxes does nothing to assure increased investment.”

Higher tax rate, gross floor

The tax rate under ACES is 25 percent, up from 22.5 percent under PPT.

And there is a 10 percent gross-based tax floor on legacy fields. The governor called this “a meaningful minimum tax based on gross receipts for our legacy fields like the giants Prudhoe and Kuparuk.” The fields have been in production for years, the governor said. Costs have been amortized and risks are low and profits high, so “Alaskans deserve appropriate value for a resource in these legacy fields.” To protect the state in the event of significant increases in costs or a significant decrease in world oil prices, the minimum tax kicks in — “10 percent of the gross receipts; this is a gross safety net; it’s a gross floor,” Palin said.

“And it’s how we can protect our interests on the downside while sharing the upside during high oil prices.”

By contrast, she said, the PPT reduces state taxes to zero when oil prices drop below $34 a barrel.

“It’s not appropriate to eliminate the tax on the legacy fields; they’ve been our bread and butter over all these years,” Palin said.

Transitional investment expenditure credits — credits for work done over the five years before PPT kicked in — are eliminated under ACES and capital expenditure costs must be taken as credits over two years, rather than immediately.

ACES has a progressivity feature but it kicks in at $30 net value (annual) and rises at 0.2 of a percent per dollar. The PPT progressivity feature kicked in at a higher oil price but rose faster and was calculated monthly.

ACES “restricts capital expense deductions to scheduled maintenance,” the governor said, fixing the corrosion issue addressed in Senate Bill 80.

“We’re saying: industry if you’ve deferred maintenance on your pipes and now they’re corroded, you’ll fix your pipes and you’ll not charge the state for those fixes,” Palin said.

The investment analysis

Galvin discussed some of the analysis the Department of Revenue did in conjunction with the Department of Natural Resources to model how different tax regimes would impact different types of projects.

DNR has proprietary data on projects that was used in modeling, but Galvin said to protect the confidentiality of the data he couldn’t say what projects were used, just that they included “a new standalone development, an infield development within existing infrastructure, a remote development project far removed from existing infrastructure and a heavy oil based project.”

Projects which had a positive net present value of cash flows at a 10 percent discount rate under PPT were also positive under ACES — or negative depending on the case — although the companies stood to make more on the projects under PPT than under ACES, while the state would receive more from all production taxes (not just these projects) under ACES — $2 billion at $60 a barrel oil, compared to $1.3 billion under PPT.

ACES was the most successful case of many different types of taxes modeled, Galvin said.

“We have the gross-based floor to protect the state in the low-priced scenarios; we have a net-based approach to attract the investment; and also with the net-based approach we can push the tax rate and generate the income that we need without substantially affecting the investment climate. And it’s that balance that we believe we’ve struck with the ACES program,” Galvin said.

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