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Vol. 11, No. 32 Week of August 06, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

Invest or pay

Alaska tax bill with variable rate based on investment in House Finance

By Kristen Nelson

Petroleum News

The Alaska Legislature may be on its way to passing a production tax revision.

Over three days in late July and early August “produce or pay” became “invest or pay” and House Finance appeared to have crafted a possible solution to the production tax revision legislators have been debating since Gov. Frank Murkowski introduced his “20/20” proposal in February.

The governor’s proposal, tied to a gas fiscal contract, would have replaced the current production severance tax and its economic limit factor with a 20 percent tax based on net profits in a plan that included a 20 percent credit on capital expenditures designed to encourage reinvestment in the state.

In the months since February legislators raised the tax rate and added progressivity, a surcharge at higher oil prices, but twice failed, in the waning minutes of the regular session and the waning hours of the first special session of the summer, to agree on specific tax and progressivity rates.

The House Finance proposal, a committee substitute for the administration’s 20/20 tax, is a tax on the net with the tax rate driven by investment level. The base rate can be “bought down” from 25 percent to 20 percent, based on the dollar-per-barrel equivalent of investment.

When the committee substitute was discussed July 31 the rate was adjusted based on incremental production.

BP and ConocoPhillips objected vigorously, telling legislators Aug. 1 that production is the outcome of investment, that volumes of production cannot be well predicted based on investment and that all needed investment isn’t directed at increasing production.

When the committee reconvened at 7:30 p.m. Aug 2, the tax rate trigger had been changed to investment.

Companies: tax rate too high to attract investment

While the proposal may or may not be a compromise legislators can live with, it will tax industry at rates the companies have described as too high to attract optimum investment to the state. The state’s largest oil company taxpayers, BP, ConocoPhillips and ExxonMobil, are the sponsors of a gas pipeline proposal. The companies have said they think the governor’s 20 percent tax rate is too high, but accepted it as a way to move forward on a gas project.

At current investment rates, the average rate for the “invest or pay” proposal would be about 22.5 percent.

“This is a compromise on the produce or pay concept,” said Rep. Ralph Samuels, who with Rep. Mike Hawker, both Anchorage Republicans, has been driving work on a compromise. “For those that choose in reinvest in Alaska, we will give them consideration on their tax rate,” he said in a statement after the Aug. 2 Finance Committee meeting. “We hope to incentivise higher production which is critical to our economic future.”

Committee Co-Chair Mike Chenault, R-Nikiski, said he would give committee members an opportunity to study the amendment and would hear testimony from the oil industry; he said he hoped to move the bill out of committee Aug. 3.

Tax rate not fixed

Dan Dickinson, former director of the Department of Revenue Tax Division and now a consultant to the department, told the committee Aug. 2 that the tax rate will vary from 20 percent to 25 percent, depending on how much reinvestment an investor makes in Alaska. By reinvesting, the taxpayer can “buy down or invest down” the tax rate to 20 percent. For those not investing, the tax rate would go to 25 percent.

Investment affects just the tax rate, he said, not progressivity or alternative tax measures in Cook Inlet.

Because of the difference in the size of the producers, and the investments they make, the tax would figure investment on a dollar-per-barrel measurement. Dickinson said that if investment across the slope was $2 billion in a year, the tax rate would be 20 percent, so at an investment rate of about $1 billion a year, the average tax rate would be 22.5 percent.

The formula doesn’t reward all investment: that below $1 a barrel doesn’t buy down the tax level.

North Slope investment over five years averages out to about $3.42 a barrel, Dickinson said, although individual rates vary. The tax rate is specific to each company and its investments.

Dickinson said BP’s Tom Williams presented materials on gold plating, where at high oil prices, investments are made just to drive down the tax rate, but aren’t useful investments driving production.

To prevent that, in this proposal the producer has to be paying at least 25 cents on the dollar. Investments are still attractive, he said, but not so attractive that you wouldn’t otherwise be making them.

Samuels told the committee July 31 — when the proposal was production-based — that he and Hawker first looked at basing the tax rate on investment, in effect allowing companies to buy down the rate of their tax, but were told by both Pedro van Meurs and Dickinson that at very high oil prices you could find companies spending at a very high rate just to buy down their tax rate — “gold plating” — so they switched to production as a method of determining the tax rate.

Samuels said the problem with production is represented by Badami: hundreds of millions of dollars were spent for almost no production.

Robynn Wilson, director of the Tax Division, reviewed other changes to the draft bill, filling in blanks for progressivity (a 0.25 slope, a maximum rate of 25 percent and a trigger of $40 net production tax value).

The base allowance credit remains the same as in the conference committee language, she said: $12 million, based on production, so it’s geared to small companies.

The July 31 production alternative

The draft version of the bill presented July 31 was a concept, developed by Hawker and Samuels, based on incremental production.

Administration consultant Pedro van Meurs told House Finance July 31 that Kuwait, Venezuela and some West African nations use this approach. Base production would be based on 2005 figures; the tax rate would reflect 75 percent of that number and be reduced by 5 percent each year to reflect field decline.

Any excess over the base is counted as incremental production, van Meurs said, and is taxed at reduced rate, rewarding companies for investing in the state, with incremental production taxed at 15 percent, base production at 25 percent. Starting in 2012 the incremental rate would begin to increase at half a percent a year until it merged with the base rate.

The 5 percent decline does not represent a do-nothing investment rate, van Meurs said; without any field work decline would be 8-12 percent a year.

Industry response

Both BP and ConocoPhillips objected to the production-based approach in presentations to the committee Aug. 1.

Ken Konrad, BP Exploration (Alaska)’s vice president for gas said the gas sponsor group (BP, ConocoPhillips and ExxonMobil) agreed to the governor’s proposal of a 20 percent tax rate and a 20 percent credit in order to get to a gas development. That is a $1 billion a year increase taxes, Konrad said. The governor’s tax proposal “wouldn’t get maximum investment,” Konrad said, and told the committee that if the policy objective is to maximize investment the production-based tax rate wouldn’t do that.

Production is the outcome, he said: if you want to encourage production you’d probably better do that directly.

BP’s senior tax and royalty counsel Tom Williams made the same point: “production is the output — investment is the input,” he said. With higher risk you need a higher reward. There will still be attractive opportunities, Williams said, but not so many.

Williams also disagreed on how established companies and new players are treated. Because of the blended rate, “we spend a billion dollars and we get a 22.5 percent rate; a newcomer from the first dollar enjoys 15 percent. That’s a serious difference,” he said.

Brian Wentzel, ConocoPhillips Alaska’s vice president of finance and administration, told the committee ConocoPhillips believes the pay or produce is a “flawed” approach with arbitrary values that would add complexity and is likely to cause unintended consequences. The 15 percent rate for incremental production wouldn’t be an incentive to either exploration or heavy oil development he said because that rate would phase out before much production could come online.

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