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Vol. 11, No. 16 Week of April 16, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

CI execs want changes

Marathon urges lower Alaska tax; Chevron calls for fair progressivity

Kristen Nelson

Petroleum News

The Alaska Legislature’s Senate Finance committee heard strong recommendations for changes in the proposed production profits tax from Cook Inlet producers Chevron/Unocal and Marathon Oil April 6.

John Zager, general manager of Chevron’s Alaska assets, proposed a simplified progressivity feature and both Zager and John Barnes, production manager for Marathon Oil in Alaska, recommended a lower tax rate for Cook Inlet.

Barnes said he thought the production profits tax for the inlet should be 5 percent, rather than the 20 percent proposed by the governor and retained in the House Resources committee substitute, or the 25 percent rate in the Senate Resources CS. Barnes said Cook Inlet must be compared to North American gas opportunities, not international opportunities. It does not have world-class exploration prospects, he said, although it does have smaller exploration opportunities. Barnes said on the plus side for Cook Inlet is good access to land, but that is offset by high costs, the permitting and regulatory burden, the price and closed market.

There is nothing wrong with the existing severance tax and its economic limit factor, or ELF, for Cook Inlet natural gas, he said, and told the committee a 5 percent net profits tax would be close to the existing severance tax rate.

All of Marathon’s Cook Inlet production is natural gas.

Barnes noted that about 50 percent of the severance taxes on Cook Inlet gas are passed on to industrial users and about 50 percent to consumers through utilities; an increase in the tax, he said, will simply be passed on.

Progressivity tied to net

Zager said he prefers the bill not include a progressivity factor — an additional tax rate at high oil prices — but said if such a factor is included, it should be on net profits not gross, matching the proposed production profits tax or PPT.

Zager said the 25 percent tax rate in the Senate CS is too high: work Chevron has done indicates it will hurt economics. He said Chevron prefers the governor’s proposal of a $73 million exemption from taxes to a 5,000 barrel per day exemption: the tax is on dollars and there should be a dollar exemption to go with it. Chevron also prefers the original transition provision rather than the two-for-one provision in the Senate CS: “Requiring two for one is pretty darn aggressive,” he told the committee. If the two-for-one provision (investments over the past five years could be taken as credits but only at a rate of $1 in credit for every $2 of new investment) is in the bill, Zager said Chevron would like to see the time period to use it extended out to 10 years.

Zager said the progressivity provision is a problem because investment in oil and gas development is risky, and companies look at a distribution of possible outcomes which are all averaged back into decisions and it the Legislature takes out the top end it alters the view of the investment decision. Oil companies are in the risk business and are happy to take risks as long as we get the full range of outcomes, he told the committee.

If progressivity is included in the bill, he said it should be based on net, not gross.

Progressivity as a creeping tax increase

The reason legislators have given for a progressive tax element is to ensure the state gets a fair share when there is a price runup accompanied by large profits, Zager said.

But if there is a gradual price increase in oil and gas over time accompanied by increases in costs — not increases in profits — a progressive feature would be a creeping tax increase.

Problems with progressivity as proposed include a trigger price tied to West Texas Intermediate oil or Henry Hub gas price that is not inflated, he said. Over time prices and costs will rise, Zager said, and a trigger price that is not inflated will not work as intended.

He recommended a net profits trigger, telling the committee that since companies will already calculate net profits every month in order to pay the PPT, they can divide that amount by the barrels of oil equivalent produced (oil and natural gas reduced to a common number) and then a trigger point and escalation factor can be set based on net profits per boe.

Zager suggested a $50 per boe net profits trigger with a 2 percent tax rate for each $10 increase in profits with the minimum general rate of 20 percent tax and a maximum general rate of 30 percent with the progressivity factor added.

This would be self correcting for inflation of costs and commodity prices while fully capturing any windfall upside, without creating unintended consequences, he said.

Captures only windfall

Zager said such a net profits trigger would capture additional profits for the state in the case where there was a sudden runup in oil prices without accompanying rise in costs, while the tax would not rise in the case of a long-term price rise with an accompanying rise in costs, avoiding the problem of a tax rate which simply creeps up with inflation in oil prices, irrespective of an accompanying rise in costs.

Sen. Bert Stedman, R-Sitka, said progressivity based on gross was better for the state because it was less likely to be manipulated and would be less impacted by credits.

Zager noted that the PPT itself is a net profits tax, and said a progressivity element based on net would be no more subject to manipulation than the basic monthly tax. The monthly net will be “highly scrutinized” by the state, Zager said. Once the state and companies agree on the tax he said he didn’t see where there was another level of manipulation since it was the number already generated divided by the barrels of oil equivalent.

On the issue of credits Zager said he thought having a lot of credits to deal with would be a good thing, since that would mean investment and production and royalties would go up, making the pie bigger. He noted this was one of the dangers of looking at one of the little pieces in isolation, since the state earns more from royalties than it does from production tax.

House interested

In a panel question and answer session in the House Finance Committee April 10, Zager said he had floated an idea to change the progressivity paradigm and tie it to net profits and barrels of oil equivalent. Consultant Daniel Johnston called it a decent design and said that as a matter of fairness it would be a contradiction to have a progressive tax element based on gross while the tax was based on net. He said it would be more consistent with theory and fairness if the progressive element was based on profits per barrel.

Rep. Mike Hawker, R-Anchorage, said he had spent a lot of time looking at Zager’s proposal and called it a “silver bullet solution” that solves a lot of issues and asked committee members to look at incorporating it into a House bill.

Rep. Mike Kelly, R-Fairbanks, asked Johnston if the net profits basis met the test of a healthy system and Johnson said that test — if the companies save a dollar do they get to keep any of it — is met by a profits-based mechanism. A profits-based tax increases the incentive for companies, he said, and called the design “very healthy” in how it deals with costs. He said having both a progressive rate and a base on net is “virtuous, healthy good. ... We’re on track,” Johnston said.

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