The Alaska Legislature got a briefing Jan. 18 on one part of the gas pipeline fiscal negotiations — a proposed revision in the state’s oil and gas production tax. This would be, petroleum economist Pedro van Meurs told legislators, a law of general application, and would need to be passed before a stranded gas contract can be considered.
There have been calls for a progressive oil and gas tax in Alaska, van Meurs said. And now, with oil prices so high, the time is right to scrap Alaska’s production tax system and the economic limit factor and institute a profit-sharing production tax, a progressive tax which will give the state more of the take when prices — and profits — are high. On the down side, if oil prices drop so low that there are no profits for companies in Alaska, then the state gets no taxes. Other oil and gas taxes — royalties, property tax and the state’s corporate income tax — would not change.
An administration bill for a profit-sharing production tax will be introduced soon, van Meurs told legislators. He said he was giving an introductory briefing, to obtain feedback and exchange ideas before the final legislation is prepared. The profit-sharing production tax will be a law of general application, he said, will apply to all oil and gas production in the state.
“If the Legislature approves that law,” he said, then there “will be a possibility of tying that into the total negotiated framework” for a gas pipeline. “But first we need a law that on its own merits stands up as a good law for Alaska.” The profit-sharing production tax “will be presented as a standalone law of general application and this PPT law has to be presented first before the stranded gas contract can be considered,” he said.
The profit-sharing production tax would replace the state’s present ELF-driven production tax. That tax was innovative when it was established in 1989, van Meurs said, when oil prices were $14 to $17 a barrel, and remained so even in 1996 when he first began to consult with Alaska. But over the last year, with oil prices so high, “it’s becoming such an enormous loss for Alaska compared to what other nations will collect that are in a similar position.”
The problem with ELF
The problem with the present production tax system, van Meurs told a joint meeting of the House and Senate Resource committees, is illustrated by Kuparuk: the second largest oil field in North America pays almost no production tax because of ELF and within two years will pay no production tax. “It is ridiculous to have a world-class oil field that no longer pays production tax,” he said. Within 10 years Prudhoe Bay will essentially be the only field paying production tax.
ELF was designed to lower the production tax for smaller fields and for fields with low productivity wells, he said, and “served the state well for a number of years.” But, he said, the ELF formula gives results “no longer in keeping with the economics of the state oil and gas industry.” In 1989 300 barrels a day was the benchmark for a marginal oil field, and the ELF formula “is extremely sensitive to the number of wells in a field.” With a large number of wells in a field the tax is zero; with fewer wells in the same field the tax could be very high. The rate is 12.25 percent for the first five years of production and 15 percent thereafter, but the ELF multiplier ranges from zero to one, so the actual tax rate can be from zero to 15 percent.
ELF also does not respond well to oil field decline, he said. “And above all, the ELF does not provide sufficient incentive for reinvestment.”
Initially the formula produced good results, he said: “It definitely promoted the development of smaller fields” on the North Slope. “But now the benchmarks are outdated ... (and) it is now time for an overhaul.”
Benefits of PPT
Van Meurs said Norway produces about half the oil and gas per capita as Alaska, “but Norwegians are 50 percent richer.” In Norway, he said, there is a profit-sharing production tax which helps Norway keep money in the country.
The present tax is a field-by-field tax while a profit-sharing production tax, or PTT, will be a consolidated tax at the corporate level based on the cash flow each company receives from oil and gas production in Alaska, with tax credits to encourage investment.
The PPT would be calculated based on gross production, minus royalties, minus oil and gas expenditures related to production. “A very simple concept,” he said: “You take the gross revenues and you deduct all the costs.” With high oil prices and a large amount of cash, which is the case today, “then the share for Alaska is large. If it’s a lower amount of cash then the share is lower. That is a fair system for both parties,” he said. And it is a system used by some 25 jurisdictions world-wide, while a related system, production sharing, is used by some 50 jurisdictions.
A profit-sharing system is “an automatic system to encourage reinvestment,” he said: “If you take your dollar out, you pay the tax. If you reinvest you don’t pay. That is what builds oil production. That is what builds gas production. That’s what builds an oil industry. Other nations have figured that out,” he said, “Alaska doesn’t have that. If you take a dollar out of Norway, what happens? Seventy-eight cents taxed on that dollar. If you take a dollar out of Alaska what happens? Nothing.”
Encourages new entrants
The proposed profit-sharing tax will also encourage new entrants because companies can convert the losses they have in the early years — before they have production — by converting losses to a tax credit that can offset taxes in future years but can also be transferred. “So that means somebody that comes in and invests a dollar, receives right away tax credits back because they can be sold to others — that immensely increases the attractiveness of new entrants investing in Alaska.”
Tax credits are used to create a progressive system in the proposed profit-sharing production tax because the state wants to attract new entrants and wants to encourage smaller oil companies, van Meurs said. “The easiest way to do that is through tax credits.” Other features favorable to small independents and explorers are being considered, he said.
The proposed profit-sharing tax is “based on actual economics and generates a tax when there is a reasonable profit,” he said, and “provides a reasonable balance between the state and the producers over a wide range of oil prices. That strongly encourages investments and reinvestment in the state,” van Meurs said.
The general principle, he said, “is that of course the overall revenues to the state must be significantly higher at today’s prices. And if I say significant, I mean significant: I don’t mean another 10 percent.” A profit-sharing tax provides a “fair balance” and reduces the risk to investors: “When the price is low we share with them the burden; if the prices are high we share with them the benefits.”
New environment for Alaska
A profit-sharing tax will create enhanced incentives, “an automatic reward for investors.” That, combined with a gas pipeline, “will create a whole new environment” in Alaska, van Meurs said, adding that he believes many oil companies “will consider Alaska a new core area for petroleum investment and increased oil and gas production.”
Worldwide competition “has become significantly stronger,” he said, with some 200 international oil companies creating “exceedingly competitive” bidding rounds, “and consequently the Alaska framework that is being offered here will be a very positive framework to ... new investment.”
