Piecemeal there are a number of impacts from House Bill 247, but the greatest danger is that industry sees it as a slippery slope with the state coming back year after year to take more and more revenues from oil production in Alaska.
That was the message from the Legislature’s consultants, enalytica, who spent a number of hours over several days at the end of February going over HB 247 with the House Resources Committee. The bill is the Walker administration’s proposal to change a number of things in the state’s oil and gas production tax system, the most recent version of which, Senate Bill 21, was enacted in 2013 and upheld in a voter referendum in 2014.
Janak Mayer, chairman and chief technologist of enalytica, told legislators that while HB 247 is not a tax overhaul, it includes a number of major changes, some of which target legitimate concerns. The bill also, he said, introduces a series of incremental tax hikes, with what he described as “highly variable” impacts depending on the company and its investment profile.
Most companies, he said, will see what he described as “substantial adverse effects,” with retroactivity on some changes and a July effective date for others presenting “additional challenges for ongoing operations.”
Issue of stability
Mayer said stability is the most important element in a fiscal system. As long as a system is broadly competitive, he said, and doesn’t have horrendous problems, what matters more than anything is that when investors make decisions they know the terms they counted on will remain the same into the future.
Because HB 247 contains a collection of incremental steps, each of which is a small tax hike, Mayer said it’s easy from an oil company perspective to see the state simply finding a little more revenue it can take here and there, creating a concern that such changes will continue in the future.
The optimal tax policy for a sovereign is a big question, he said.
But from the investor’s perspective the changes - essentially raising taxes when income is low - appear to be just extracting money, rather than being part of a well thought out policy.
The overall impression is salami tactics - slice by slice by slice to get more revenue - and Mayer said the first question is where does that stop, leaving the investor to ask if there are these changes this year, what am I looking at next year?
Gross and net
Alaska’s tax system includes both net and gross taxes.
Royalties and the gross minimum ensure substantial petroleum revenues even when commodity prices are low, Mayer said, but a gross system can be distorting when prices are low and costs are high, making it difficult to invest.
Alaska’s royalties are regressive, with very high government take when prices are low, while its progressive net production tax brings in more money at high prices, but much less at low prices.
The proposed changes in HB 247 would make a regressive system even more so, he said, and the cumulative impact of the proposed changes would be to shift up government take at lower oil prices.
Oil prices are much lower than when SB 21 was passed, but Mayer said the one thing he didn’t think anyone counted on during that 2013 discussions was that major North Slope operators would have net operating losses. The situation the state now faces, he said, is just extracting money - not taxing value because there’s no value to be taxed, but just wanting money because we’re the state and we need money.
Monthly reconciliation
Mayer laid out some of the major changes proposed in HB 247.
One of the changes, the basis on which tax liabilities are assessed, is currently annual. Mayer compared it to the federal income tax which is paid on annual earnings, thus smoothing payments for taxpayers whose income varies from month to month.
Because tax liabilities are assessed annually, he said, the impact of price volatility is smoothed out.
HB 247 proposes that per-barrel credit and gross minimum tax would be calculated monthly. Done this way, the state would have received some $100 million in additional revenues in 2014, Mayer said, because there was a lot of month-to-month price volatility in that year.
A tax hike happens with this change, he said, because it’s a heads, the sovereign wins, tails it’s a tie: If the price remains stable, there’s no difference, but if there’s volatility, the sovereign wins.
And because this is done monthly, the taxpayer has to figure costs each month, which means taxpayers need to figure taxes monthly, Mayer said, whereas currently a monthly estimate is based on the annual estimate divided by 12.
GVR, NOL
A second feature HB 247 proposes to change relates to the gross value reduction and net operating loss credit. Because the gross value reduction artificially reduces production tax value, and net operating loss credit is based on PTV, the 35 percent NOL credit can be given on a loss greater than the actual loss, effectively providing more than 35 percent support for spending.
HB 247 would assess NOL credit on actual loss, not including the gross value reduction, so NOL is 35 percent of the actual loss and all producers have 35 percent support for spending.
Mayer said it’s a legitimate point that he hadn’t thought about, and is an important point raised by the administration. The question is whether the greater than 35 percent support for GVR oil was a deliberate incentive or an unintended consequence under SB 21.
He said he thinks the goal of SB 21 was 35 percent, but also thinks that because investments have been made under SB 21, any change such as this seriously affects those investments. Mayer said he thought SB 21 was clear on 35 percent, but models based on the law produced a higher level of support.
Gross minimum tax
A third proposed change is in the gross minimum tax. Currently, the 4 percent minimum is binding for legacy oil if net value is positive, but if net value is negative, NOL can reduce taxes below the 4 percent floor.
New oil, which is eligible for gross value reduction, can take the minimum to zero due to the $5 per barrel and small producer credit.
HB 247 would harden the floor for all production, not allowing NOL credit to take the tax below the 4 percent floor for legacy production and not allowing NOL, small producer and $5 per barrel credit to take the minimum tax below the 4 percent floor for GVR-eligible production.
HB 247 would also raise the minimum from 4 percent to 5 percent.
The impact would be that state revenues would rise at low oil prices, and for many new fields, the minimum tax would go from zero to 5 percent at current prices, while for legacy production, the rise in taxes would come at a time when the value is negative.
Mayer said the concern to protect the state at low oil prices is always valid, but also said that competitive fiscal regimes balance risk and reward at the low and high end of the price range. At low prices, taxes quickly take everything from existing producers, he said, and the regressive nature of royalty means the state can take more than everything.
NOL credit reimbursement
A fourth issue Mayer identified is the net operating loss credit reimbursement.
Currently, producers with more than 50,000 barrels per day of production must carry NOLs forward, while others can be reimbursed by the state.
HB 247 proposes an annual limit of $25 million on reimbursement per company, while requiring that companies with more than $10 billion in annual revenues must carry the credits forward, regardless of their Alaska production level.
Mayer said while he thinks there is a strong case for the sovereign protecting itself with some cap, he also thinks the level of the cap is an issue, and noted that for a hypothetical $1.3 billion development the $25 million per year cap would increase capital needs by 33-50 percent, from $300 million to $400-$550 million, based on an estimate of how long the company would need financing until production began to provide cash.
In addition to substantially increasing capital needs for new developments, Mayer said that if effective this July, the change would have major negative impacts on developments already underway.
He said there would be a “really chilling impact” on industry from making a change like this and doing it immediately.
GVPP
Mayer said under another significant proposed change under HB 247 the gross value at the point of production wouldn’t be allowed to go below zero. The issue, he said, is that the North Slope is not a ring-fenced system. Producers are taxed based on production across the North Slope, not just at a specific field. If GVPP can’t go below zero, Mayer said, then producers will have costs they can’t charge against production elsewhere, a change if a producer did a project based on the belief that costs could be written off against production across the Slope.
