House Finance began hearings on the Senate’s version of the production profits tax at the end of April, then stepped away from hearings on PPT to work on budget issues. The committee was scheduled to take up work on the PPT again May 4, just as this issue of Petroleum News was going to press.
When consultants discussed the Senate CS for Senate Bill 305 April 29, House Finance heard concern from the administration’s consultant Pedro van Meurs on the 25 percent credit rate and from the Legislature’s consultant Tony Finizza speaking for Econ One on the exclusion of two-thirds of natural gas from taxation.
Timing issues for completion of work
Members of the House’s Republican leadership addressed the issue of when PPT might pass the House in a May 1 press briefing.
House Majority Leader John Coghill, R-North Pole, said one issue around moving PPT was getting members who haven’t been involved on a committee level familiar with the bill before it goes to the House floor; he said he planned a public walkthrough of the final House Finance version late May 4 or May 5. Since a committee version had not yet been heard May 4, this public walkthrough would have to occur over the weekend or early the week of May 8. With the session ending May 9, PPT seems likely to be the subject of a special session, followed by consideration of the gas fiscal contract in a second special session.
House Finance Co-Chair Kevin Meyer said Finance Co-Chair Mike Chenault, who is taking the lead within the committee on the PPT, wants a good bill that people understand. It’s a very complicated issue, Meyer said, and Chenault wants to make sure that it’s done right.
Coghill said the time schedule is tight enough that the PPT realistically slips into special session unless things fall into place very nicely. To this point, he said, that hasn’t been true: it’s been a “very arduous process.”
Meyer said House Finance wants to make sure it finds any glitches in the bill before it moves, and said House Finance members will be confident of the bill before it goes to the floor.
Asked if the governor would release the gas contract May 10 if PPT does not pass by May 9, Coghill said that was an unknown, although the expectation was that the governor would release the contract on the 10th, which might change how the PPT is viewed.
House Rules Chair Norm Rokeberg, R-Anchorage, said that members of the legislative leadership have asked the governor for release of some of the fiscal terms, if not the whole contract. Enough, he said, that legislators could see whether some of the impacts of the PPT on gas would be neutralized by arrangements in the gas contract.
Rep. Hollis French, D-Anchorage, is suing to have the gas contract released and the judge’s decision is expected May 5.
Pedro van Meurs: 25% a concern
Van Meurs said April 29 that the 25 percent credit rate in the Senate CS is an issue that concerns him “deeply.”
The governor’s proposal was for a 20 percent tax rate on net profits coupled with a 20 percent credit rate.
Van Meurs said he recommended against such a high tax credit, but hadn’t explained to the Legislature why. Before the PPT was presented, he said, there was an extensive analysis done on heavy oil because heavy oil will be so important to the state in the future.
In the analyses that were done economist Roger Marks of the Department of Revenue assumed that much more light oil might become available, but van Meurs said his assumption is that heavy oil is much more important to the state and worldwide.
At long-term prices of $35 a barrel 2 billion to 5 billion barrels of heavy oil could be recoverable on the North Slope, he said. But all heavy oil isn’t the same, and as you go from the best heavy oil, at 25 degrees API gravity, down to oil at 10 degrees API, the cost of production goes up and the value of the oil goes down.
Van Meurs said he looked very carefully at a 25 percent credit rate, and “reluctantly” came to the conclusion that it wasn’t a good idea because if you have high-cost low-value oil, the opportunity for loss carry-forwards at low oil prices increases.
“I came reluctantly to conclusion that Alaska simply cannot afford such high tax credits,” van Meurs said. At prices of $34 or less a barrel there would be too much of a loss, he said.
Progressivity, tax rate issues
On the progressive feature in the Senate CS van Meurs noted it has been defined with oil prices in nominal dollars. If you define the progressivity trigger — the point at which a surcharge begins — in nominal terms, he said, without escalation, then the value will erode over time as inflation continues. The value of a starting point of $50 today could erode to $25 in real dollars of today in 30 years time. He cautioned legislators that if they included a progressive feature they should look at the starting point “somewhat carefully.”
Van Meurs said he has testified on the relationship between competitiveness and tax rate. He said his work has indicated that “the higher the tax rate the less the Alaska system becomes competitive with other systems in the world.” Level of activity and tax rate go together, he said: the higher the tax rate, the less attractive Alaska is at a given rate of credits. It may not matter if oil stays at $40-$50 a barrel, he said, but if oil companies are looking at a long-term $35 price, and lower stress prices, then the tax rate matters. Alaska crude oil already has a netback $5 less than other crudes in the world, he said, consequently if the tax rate goes up, “my prediction is that activity level goes down.”
Competitiveness studies were done on light oil, he said: Alaska looks a lot less competitive when studies are done on heavy oil because of the greater importance of the lower netback.
And with Alaska production declining, the state needs to encourage more investment, he said.
Senate separates gas tax
Van Meurs liked the gross revenue exclusion for natural gas in the Senate CS, and said it was very much in line with the international trend. With transportation costs for North Slope gas, ANS gas would have one of the lowest netbacks in the world. In nations faced with long-distance shipment of gas to market, he said, most of those governments have decided their take for gas should be less than for oil. The Senate concept is “in line with international policies and competitive,” he said.
Van Meurs got questions from Reps. Reggie Joule, D-Kotzebue, and Bruce Weyhrauch, R-Juneau, about treatment of gas in the PPT. He said the PPT bill had always applied to oil and gas, that there was never a plan to separate them because “we didn’t want to have to separate out capital costs for oil and capital costs for gas.”
Because there might be gas producers on the North Slope not part of the gas fiscal contract, it’s important to make sure the PPT law is good for gas and good for oil, van Meurs said.
Rep. Beth Kerttula, D-Juneau, said she was concerned that it was a “terrible risk” to have a higher tax and a higher credit for both oil and gas, and said she believed the state “can’t help but lose money” over the long term.
Van Meurs said credits for gas in the PPT, primarily upstream credits for Point Thomson and development of some new gas fields, have already been discounted in information presented to the Legislature. Van Meurs said he understood the concern, but the credit part of the gas project has already been presented and “there is no need to fear additional credits against gas.”
Van Meurs said if it costs $2 billion to develop Point Thomson, the credit at 20 percent would be $400 million. Roger Marks already deducted that amount in presenting revenues from a proposed PPT, he said. He also said Point Thomson facilities will be partly for oil, since the field will generate condensate for oil production. The belief was, he said, that it would be too complex to separate out what part of an investment should be charged to oil and what part to gas.
Van Meurs said the original PPT had the same rate, 20 percent, for both oil and gas, with the intention that the $73 million allowance for small players would protect Cook Inlet. He said he thinks the Senate is correct in its view that assuming the gas contract goes forward, there may be North Slope producers of gas who are not part of the gas contract and the PPT has to be good for them.
Issue of downside
Rep. Mike Kelly, R-Fairbanks, asked about incorporating a floor in the PPT to protect the state in the event of low oil prices.
Van Meurs said that was why he was so concerned about the 25 percent tax credit: when we did background on the PPT we modeled a minimum tax amount but didn’t recommend that because typically minimum taxes around the world are recoverable if the price goes back up, in other words they are subject to a carry-forward provision, which makes them the equivalent of an interest-free loan to the government during periods of low prices.
While PPT would generate less at low prices, the present system of the severance tax with its economic limit factor would be generating almost nothing 10 years out.
Van Meurs said the second reason he doesn’t feel there is a need for a floor is that Alaska is “unusually well protected on the downside” with its royalty system, property tax and state corporate income tax based on worldwide taxes. If the netback becomes low in Alaska, he said, it wouldn’t necessarily be low internationally, so Alaska already has better downside protection than most regimes.
Econ One: credit rate not a concern
Tony Finizza testified on behalf of the Legislature’s consultant Econ One.
He said concern over the credit rate has gotten a lot of attention, as has a range of crude oil prices from $20 to $80 and a tendency to think all prices are equally likely. Finizza said the oil price distribution he has presented is based on a mean or expected value of $40 West Texas Intermediate, which seems equivalent to the $35 Alaska North Slope price van Meurs has used because of quality and transportation issues. There is no one view of the future, Finizza said: you could get $25 and could get $55, but the “central tendency” is probably $40, he said, noting that all economists have been humbled by forecasting errors. Looking at the Department of Energy’s forecasts what is now their low case was their base case just two years ago: “A lot of people believe prices have moved up,” he said.
Finizza said he did some analysis on what a 25 percent credit rate would mean and concluded that for exploration plays the state had about a 35 percent chance of a negative tax due to a 20 percent credit rate, so you could probably add another 5 percent at a 25 percent credit rate. It’s already “highly risky” for exploration plays at 20 percent. Finizza said he doesn’t think a 25 percent credit rate does that much more damage.
The chance of the state having a negative tax position for satellite developments is just 1 in 4 at the 20 percent credit rate, Finizza said, and drops to 5-6 percent for investments in legacy fields, so he didn’t think a 25 percent credit would add much risk.
There is natural protection for exploration plans because at low prices, $20-$25, there wouldn’t be much exploration.
Balance needed on progressivity
Finizza said producers have called Alaska a “price play,” and if the state provides some incentive on the downside it needs to leave some of the upside. He called for a balance: oil companies do need some of the upside or they might not take any risk, he said.
He said he thought $50 sounded about right as a trigger point for a progressive surcharge, but thought the nominal dollar trigger could be a problem and might cause producers to rethink investment. If costs rise in excess of inflation and prices rise at inflation, a progressive tax on a nominal trigger could result in the state taxing an eroding margin, Finizza said.
He said one solution was to index the trigger to inflation or make it sensitive to changes in cost.
He also suggested capping the progressive tax rate.
He stuck with the position Econ One has taken in the past: that in the 20-25 percent tax rate range there doesn’t seem to be a major change in investment.
He also said that he doesn’t think there is any doubt that higher tax rates produce lower investment, but said he thought people were ignoring the effect of investment rising as prices rise.
Finizza said Econ One believes there will be more investment at today’s prices under the PPT than under ELF at yesterday’s prices; the system plus the environment, he said, should give us more investment.
Did they mean two-thirds?
Asked by Kelly about the provision in the Senate CS that would tax only one-third of the gross value of natural gas, Finizza said when he heard that he thought maybe someone had meant to say two-thirds. He speculated that it might be an attempt to correlate to something, perhaps Prudhoe Bay numbers under the current ELF, but he wondered what the goal was.
Looking at Point Thomson, he said he thought the logical thing would be to put all the capital against gas since oil is the byproduct at Point Thomson, not gas.
Finizza said he didn’t think taxing only one-third of the gas was workable and said he didn’t have another number to recommend. He said he didn’t feel he had a “magic silver bullet” on that issue, but said: “a third doesn’t sound right; that’s not right.”
Kelly also noted that the North Slope might not be the only area where taxing only a third of the gas could be a problem. If they find 3 trillion cubic feet at Nenana, that’s a different deal than if they find only enough to do something for Fairbanks. He said he thinks Alaska is big enough that larger fields could be found, and said there is a problem of going with something that tries to fit everything.
Chenault said the goal in the Senate version might have been a fix for gas in Cook Inlet or south of the Brooks Range, but said he didn’t know what transpired when the gas provision was put into the bill.
For a copy of Econ One’s report go to
http://www.akrepublicans.org/senres/24/pdfs/senres_sb305_50.pdf
Some pages were later revised. They can be found at http://www.akrepublicans.org/senres/24/pdfs/senres_sb305_78.pdf
For Econ One’s draft Excel spreadsheet that illustrates how the “progressivity on net” mechanism works go to http://www.akrepublicans.org/senres/24/pdfs/senres_sb305_77.pdf
