The Alaska Department of Revenue used publicly available cost data from 2002-05 when it assembled a fiscal note on expected North Slope production and operating and capital costs for the legislation that created the state’s petroleum profits tax, or PPT, in 2006.
When tax returns came in earlier this year, however, costs — both operating and capital — were about twice those projected in the fiscal note.
The Legislature asked Econ One Research to review Revenue’s modeling for the 2006 fiscal note — and the modeling used in the department’s Aug. 3 status report on PPT, which addressed the increase in costs and the corresponding reduction in projected revenues from PPT.
In presentations to House and Senate Finance committees Nov. 7, Barry Pulliam, senior economist with Econ One, said the firm was asked to compare the estimates done for the PPT legislation with current estimates and to explain why costs came in so much higher than projected.
Revenue used 2002-05 information, Pulliam said, pulled together in 2005 and early 2006. This included cost information available from Securities and Exchange Commission filings for producers that break out costs in Alaska, confidential income tax filings and private consulting work on North Slope costs.
Pulliam said the fiscal note costs line up with information available for 2002-05 for Alaska, a total of $2.1 billion for operating and capital costs.
In August, Revenue forecast lease cost increases for the current fiscal year, FY 2008, of nearly $2 billion, almost doubling the 2006 fiscal note estimate. The August figures are from PPT tax filings that have come in to date, Pulliam said. Those returns have not yet been audited and Revenue is taking those costs as filed and using them as projections, he said.
Costs driven by prices
Pulliam said prices have been driving costs up.
The “dramatic long-run increase in oil prices” over the last few years is primarily to blame, he told legislators, and noted that just a couple of years ago when they ran price charts going out to $75 a barrel that per-barrel price seemed excessive to many.
As a cost driver, expectations are more important than the current price, he said. The futures market provides one measure of expectations. In 2005, futures topped out at around $60 a barrel; the current futures price is $80 for December 2011 delivery — $15 below the current price, he said, reflecting a general expectation that oil prices have shifted up.
The increased activity due to price expectation puts pressure on costs, Pulliam said.
The oil price is impacted by geopolitics — the current unrest in the world — and by uncertainty about the extent to which the Organization of Oil Producing Countries, the world’s swing producer, will be resolute in keeping up the price, something Pulliam said OPEC has considerable ability to do.
The market also recognizes that the places where oil is found are increasingly expensive.
Pulliam said the low price case oil companies used in evaluating projects was generally assumed to be about $25 a few years ago; today it is understood to be $40-$50.
Info on cost increase
Revenue is unable to provide information on cost increases by field or by producer because of taxpayer confidentiality issues, so Pulliam said Econ One looked for publicly available information on oil and gas costs.
Data released by Cambridge Energy Research Associates in May provided an index for upstream capital costs with 2000 as a base year, he said. Oil and gas capital costs rose generally in line with inflation through 2004, and then in 2005 began to rise steeply. With 2000 pegged at 100, capital costs in 2005 rose from a level above 110 to above 140 by the end of the year, continued to climb in 2006 and reached an estimated level of 180 in the first quarter of 2007, almost doubling. Pulliam said there is some indication of flattening in this index, which is to be expected as suppliers of goods and services to the oil and gas industry gain confidence in a long-term demand increase and begin to make investments to meet that demand.
Spike in Alaska costs
As for the spike in Alaska costs, Pulliam said Econ One did not have access to taxpayer information from Revenue, but in 2006 there was some construction and volumes from Prudhoe Bay were down following the August leak, which would drive costs up for those barrels that were produced.
In addition, the costs associated in dealing with those disruptions and increased expenditures, Pulliam said, will put pressure on all other costs you have, such as cleanup, by diverting people to those activities.
SEC filings by ConocoPhillips and BP reflect operating costs for Alaska. Pulliam said figures reported by the companies reflect increasing production costs worldwide over the last four years with higher increases in the United States, and in particular in Alaska.
ConocoPhillips showed costs beginning to rise in 2005, with a 63 percent increase in 2006 to approximately $6.40 per barrel. He said BP’s reported figures for Alaska are in the same general range as those reported by ConocoPhillips for 2003 and 2004, then rise by 38 percent in 2005 and increase sharply by 81 percent to more than $9 per barrel in 2006.
Revenue’s 2006 fiscal note estimate was $7.27 per barrel (operating and capital costs combined); its spring forecast number in 2007 had risen to $14.56 per barrel.
Pulliam noted that Revenue does not have access to information on actual and anticipated costs which would be shared between working interest owners in the fields.
Costs related to corrosion issues can only be estimated from public data. BP has said it will spend $260 million to replace oil transit lines at Prudhoe Bay and said in a 2006 form 20-F filing that it planned to spend more than $550 million during 2007 and 2008 on integrity management in Alaska. Pulliam said the $550 million figure was not identified as BP’s share or as what BP would spend as operator, although “net” was included in the description. If this is BP’s share of integrity management, the total among all of the working interest owners would be far greater than $550 million.
As for future forecasts, Pulliam noted that while Revenue did not include cost-price sensitivity in its 2006 fiscal note or its PPT status report, the department’s current forecast does adjust cost up or down when expected price levels rise above or fall below $60 per barrel.
