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Vol. 11, No. 18 Week of April 30, 2006
Providing coverage of Alaska and northern Canada's oil and gas industry

25 percent too much risk

Governor, van Meurs, Revenue respond to Senate’s 22.5 tax/25 credit PPT

Kristen Nelson

Petroleum News

The Alaska Legislature appears determined to up the ante on the governor’s proposed rewrite of Alaska’s oil and gas production tax, the production profits tax or PPT.

The Senate voted 16 to 4 April 25 for a Finance Committee substitute for Senate Bill 305 which includes a 22.5 percent production profits tax and a 25 percent tax credit, as well as a surcharge on the gross at prices above a $50 per barrel West Coast price Alaska North Slope crude. This is the so-called progressivity or windfalls profit.

The administration says a 22.5 percent tax rate is too high to bring in needed investment and that a 25 percent credit rate exposes the state to too much risk in the event of low oil prices.

Administration officials, and Gov. Frank Murkowski, have said the original legislation, with a 20 percent profit tax and a 20 percent tax credit, provides a balance between state revenues and incentives to encourage investment and reinvestment in the state’s oil and gas. The administration has also said that the proposed PPT is a progressive system compared to the current production severance tax with its economic limit factor, a tax based on a formula tied to field and well production rates.

Governor: focus needs to be on production decline

Murkowski told members of the press April 25 that he thinks the Legislature deserves a lot of credit for the thorough manner in which they have addressed tax issues, but said he thinks “they have been derelict in not focusing in on the necessity of the recognition of the decline in the Alaska North Slope production.” At present decline rates production will drop below 500,000 barrels per day within 10 years and at 300,000 bpd the economics of the pipeline become questionable, he said.

Murkowski said “investment needs to be significantly higher than the current levels of investment” and he thinks the 20 percent tax and 20 percent credit rate the administration proposed is needed to reach those higher investment levels.

The governor said the view in the Senate seems to have been that it could raise the tax rate and balance that with an increase in the credit rate.

The problem with that, he said, is “the higher tax credit rate the more risk to the state.” Murkowski said he doesn’t think that risk has been “highlighted to the extent it should be.”

The risk is partly driven by the fact that investment is going to be needed in heavy oil, which could involve “substantial investment for new technologies and new wells.” If there is investment in heavy oil followed by a period of low oil prices, credits could wipe out production revenues.

There is a “direct relationship between the tax rate and the level of activity,” the governor said. He said he thinks that has gotten lost in the debate and will make every effort to ensure that debate in the House focuses on that issue. “I would appeal to all Alaskans to recognize that we’ve got to stop the decline in oil production,” he said. “You don’t do it by increasing your tax rate; you do it by trying to reach a balance.”

van Meurs: higher credit studied extensively

Consultant Pedro van Meurs, who worked with the administration on the PPT, on both tax and the credit rates, said a 25 percent tax credit was studied specifically “because there was a strong pressure from the oil industry to have a higher credit for heavy oil.”

The conclusion, van Meurs said, “was clearly, it’s too much risk for the state.” Oil prices may be high now, but the industry is still looking at about $35 a barrel long-term, and “if you go somewhere below that the state can’t afford the 25 percent tax credit.”

He said that was why he “strongly recommended not to go for a 25 percent tax credit.”

That conclusion is well-documented in the report he presented in February, van Meurs said.

“I have tried to appeal to the Legislature to look at the risk balance,” he said.

There is a limit to how much risk the state can take because it is so dependent on oil income, “and you cannot just play lottery with it and consequently because you can’t play lottery with it, you have to be careful with these credit rates.”

In addition to looking at a 25 percent tax credit across the board he said they studied 25 percent just for heavy oil, but found even that too risky. If there were several years of low oil prices, he said, the state could face a situation where “the tax credits have piled up so much because of the very high tax credit rate that we don’t get any production tax.”

It doesn’t work across the board and it doesn’t work just for heavy oil, van Meurs said.

House Finance gets same message

Administration officials delivered the same message to House Finance April 26 when that committee began a discussion of SB 305. Commissioner of Revenue Bill Corbus said the administration continues to support its proposed 20 percent tax and 20 percent credit rate and does not support “added-on progressivity factors.”

“High taxes discourage investment,” he said. “We must not be mesmerized by current high oil prices but must encourage production.”

The focus should be not on “short-term revenues but” on maximizing “the state’s return over the long run,” he said.

Robynn Wilson, director of the department’s Tax Division, noted that SB 305 also has a special 5 percent tax rate for Cook Inlet oil, and removes two-thirds of value attributable to gas at the gross, effectively reducing the tax rate on gas to 7.5 percent before deductions, making the rate on gas probably closer to 5 percent overall.

House Finance Chairman Mike Chenault said the committee would hear from the industry April 27 and described the April 26 hearing as what is probably the start of a lengthy process.

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Gas contract May 10

Alaska Gov. Frank Murkowski said April 25 that the gas line fiscal contract the administration has negotiated with BP, ConocoPhillips and ExxonMobil will be released May 10, the first day of a proposed special session. The last day of the Legislature’s regular session is May 9, and Murkowski said he has assurances from the Legislature’s leadership that the production profits tax, or PPT, will be passed before the regular session ends.

The governor announced a deal in principle on the gas contract in February. That was followed by transmission of the production profits tax bills to the Legislature.

Murkowski said he anticipates that the call for the special session will be limited to amendments to the Stranded Gas Development Act and the gas line fiscal contract.

He said the contract will be available to the public when it goes to the Legislature.

—Kristen Nelson