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Vol. 12, No. 17 Week of April 29, 2007
Providing coverage of Alaska and northern Canada's oil and gas industry

Alaska’s PPT rides again

Bill would exclude cost deductions related to improper maintenance

Kristen Nelson

Petroleum News

Despite early fanfare and many co-sponsors, bills to restrict deductions under the state’s new petroleum profits tax (PPT) looked to be dying a slow death in both the House and Senate. But in spite of furor over last year’s transit-line corrosion at the BP-operated Prudhoe Bay field and BP’s intention to deduct pipeline replacement costs as capital expenses under PPT, House Bill 128 and its partner, Senate Bill 80, seemed to be fading in the dust behind ethics legislation and the governor’s Alaska Gasline Inducement Act.

The bills, sponsored by Kenai Republicans Rep. Kurt Olson and Sen. Tom Wagoner, would add repair and replacement costs due to improper maintenance to the list of items that cannot be deducted as lease expenditures under PPT.

The House Special Committee on Oil and Gas heard HB 128 and moved a committee substitute, but that stalled in House Resources and was consigned to a subcommittee March 28 as Resources prepared to take on AGIA. Resources has now finished its work on AGIA, but if it clears Revenue, HB 128 then has to get through House Finance, which is scheduled to begin hearing AGIA April 27.

SB 80 was referred to Senate Resources — where it got stuck behind AGIA — and also has a referral to Senate Finance, which has just begun hearing AGIA.

Shades of PPT past

Less than three weeks remain in this year’s session, which ends May 16.

But — at least on the Senate side — there seems to be hope; Resources Chair Charlie Huggins, R-Wasilla, has said he plans to move the bill out of committee April 27 after a final hearing that day.

The concept in the bills isn’t a new one.

Last year Wagoner proposed to amend the original PPT legislation in the same way; that proposal failed to pass.

2006 action on PPT has been reviewed in testimony in opposition to both bills.

April 20 testimony from Michael Hurley, director of state-government relations for ConocoPhillips Alaska, was typical of the view the companies have taken in opposing the bills. Hurley told Senate Resources that the PPT doubled ConocoPhillips’ taxes and said the company is concerned the PPT tax level will not produce the investment “we need on the North Slope to keep the pipeline running.”

He said ConocoPhillips opposes the change because the company believes it is premature, with regulations not even written defining expenditures under PPT. ConocoPhillips is also concerned with the process the bill puts in place. The bill “refers to improper maintenance, which in our view is a very, very poor standard” which lacks judicial history. The standard will be imposed, he noted, “by Department of Revenue auditors who have no real experience or expertise in evaluating the propriety of a maintenance program — especially if they only get to it in an audit cycle which can be a year to three years after the fact.”

And, he said, ConocoPhillips believes “the existing statute already deals with the kind of specific circumstances that are being brought out here.” Costs arising from fraud, willful misconduct and gross negligence, as well as costs associated with spill response and cleanup, are already excluded, Hurley said.

And there is a 30-cent-a-barrel disallowance “explicitly to cover these particular circumstances,” Hurley said.

The 30-cent disallowance is discussed in two memos from Pedro van Meurs, both written in early August last year, he said.

The two-memo issue

Resource Chair Huggins asked Commissioner of Revenue Pat Galvin for information on the memos, particularly whether one of the two was a confidential document.

Galvin said the Aug. 8 document was an internal communication within the previous administration and “probably would not have been a public document at the time.” A former member of the administration brought the document forward as part of the discussion on SB 80, Galvin said, but since the deliberative issue, the PPT, is over, the Department of Law said the document was no longer confidential.

Huggins said he called Pedro van Meurs about the memos, and said van Meurs told him he wrote the memos and meant what he said in both of them.

Hurley noted that in the Aug. 8 memo van Meurs recommended the 30-cent-per-Btu-equivalent-barrel disallowance of a deduction; that ended up in PPT, “so we are currently removing that 30 cents every month.”

He noted that van Meurs concluded that he believed the 30-cent deduction would be a good answer to public criticism that under PPT the state would pay a percentage of the replacement costs of the Prudhoe Bay transit lines.

“Mr. Chairman, this memo leads me to believe that 30 cents was meant to cover the very stuff we’ve been talking about that is at issue under SB 80,” Hurley said. You can disallow costs on a case-by-case basis, determining whether or not maintenance was done correctly, he said, or you can acknowledge that a case-by-base disallowance is administratively burdensome and put in a general disallowance.

“We believe that choice was made by the Legislature in adopting the 30-cent disallowance, which is doing it on a proxy if you will.”

What was the discussion around the 30 cents?

Sen. Bert Stedman, R-Sitka, said he remembered the discussion around the 30 cents last year, “when we were struggling with how to deal with an older basin with a lot of maintenance issues and replacement issues … so we don’t end up getting gamed. … And we worked through this issue and worked on 30 cents per barrel.”

Wagoner disagreed.

“I was the one that brought about the 30-cent issue … and it had nothing to do with how much or how little maintenance was going to be done or anything else.” Wagoner said what he asked van Meurs was to find a way to bring “the PPT bill that we had in front of us, that was based on net profits, closer to a gross bill (a bill on gross, rather than net, profits).”

“And he said one way to do it would be to calculate 30 cents a barrel. … At the time we were talking 80-some million dollars difference in the amount of maintenance that could be written off against the PPT on the net basis vs. the gross basis.”

Wagoner also noted that the amendment for the 30 cent disallowance was drafted Aug. 5 (BP announced Aug. 6 that it planned to shut down the Prudhoe Bay field in response to the spill and the corrosion found in transit lines) and was offered Aug. 9.

There was a short discussion on the 30-cent issue and the amendment passed, he said.

“But my whole point in this thing is we’re not talking about a large maintenance item. If that pipe is replaced, we’re talking about a capital expenditure.” The 30-cent amendment, Wagoner said, “was to take care of some maintenance costs which otherwise could be written off and which gave me more comfort getting us closer to a gross bill than a net bill.”

Galvin looked at memos, meeting minutes

Galvin said he had been asked whether the 30-cent deduction was intended to cover a situation where there was negligence or improper maintenance standards in maintaining equipment.

He said he looked at both van Meurs’ memos and at the committee minutes.

The first memo, on Aug. 5, was the day before the shutdown at Prudhoe. The second was dated Aug. 8.

Galvin said he believes the two are “consistent with each other in terms of their overall statement of the purpose of this deduction.

“As Sen. Wagoner stated, the intent of the Aug. 5 discussion had to do with moving the net aspect of the PPT to reflect something similar to a gross-type scenario.” Van Meurs suggested different ways that could be done — among them the 30-cent deduction. “Within the discussion of the purpose of the 30-cent deduction, there’s a discussion of the fact that equipment eventually ages and needs to be replaced and under PPT those replacement costs would be characterized as capital expenditures and would be subject to both the exemption of the 22.5 percent value and the credit.”

The question was, “should those be allowable,” and in the discussion, “the distinction between properly maintained equipment that needs to be replaced and improperly maintained equipment wasn’t really made,” Galvin said. “… It didn’t come up.”

The Aug. 8 memo came right after BP’s major announcements on Prudhoe Bay, when it was “a matter of speculation as to whether or not this was due to the aging of the infrastructure or due to some improper level of maintenance.”

The following day, Aug. 9, in the Senate Special Committee on Natural Gas Development, “Sen. Wagoner offered these amendments.”

Galvin said he looked at the committee minutes and they “provide a fairly detailed picture of how the discussion went.”

There was a good deal of discussion about how the 30-cent deduction would work and what its purpose was.

“At no place do they discuss negligence or properly maintained v. not properly maintained,” Galvin said.

What was discussed was the fact that equipment eventually needs to be replaced, and whether there should be a separate accounting of those costs so the state wouldn’t end up paying a portion.

The 30-cent amendment was withdrawn for language work.

Separate amendment on proper vs. improper maintenance

A separate amendment was introduced addressing the issue of whether there was proper maintenance and whether those costs should be deducted under PPT.

The discussion, Galvin said, was similar to the discussion now — “whether that standard can be actually implemented, whether or not that’s something that should be considered or not.”

He said that at no point in that discussion did anyone say anything about the 30 cents being intended to address the situation of improperly maintained equipment.

“They’re not intermixed. The discussions are separate.”

Later in the committee record a redraft of the 30-cent provision is introduced and passes.

Then there is an amendment by Sen. Gene Therriault, R-North Pole, which is a redraft of the improperly maintained standard, with determination to be made in consultation with the Department of Environmental Conservation and the Alaska Oil and Gas Conservation Commission. In that discussion there is no reference to the 30-cent provision, Galvin said.

“It’s considered to be a completely different issue. … Basically this is setting the standard where the previous one just had to do with any replacement of any equipment.”

Galvin said that earlier in the session he had a discussion with Revenue department personnel who participated in the 2006 PPT discussions “and they felt fairly clearly that the 30-cent haircut as it was called was intended to deal with improperly maintained equipment.” He said be believes that was the view held within the administration team. “Now that said, it was never discussed during the hearing process and I’m not sure when it actually became the position of the … previous administration” that the 30-cent provision “was meant to be all inclusive of both properly maintained and improperly maintained replacement provisions.”

Galvin said that based on his reflection on the record “it seems to me that from the legislative perspective the two were not considered to be the same issue. And the 30 cents was not intended to cover improperly maintained equipment.”

Galvin: issue ripe for discussion

Galvin said he thinks the issue is now ripe for discussion.

The standard of gross negligence is in PPT.

“And the question becomes, based upon what we have subsequently learned and what we can project out given the need for the PSIO (Petroleum Systems Integrity Office), given why we’re putting all that into place … that’s strictly a policy question from the state’s perspective as to whether or not we’re going to bear those costs associated with a particular standard of care.

“And I think that the question of what that standard of care should be is one that this committee should pay close attention to,” he said.

Revenue and the Department of Natural Resources are participating in discussions on the particular language that would be part of an amendment to the bill, he said.

“But in terms of the 30-cent question, I come away from the record at least with the understanding that it was not designed or intended to be something that covered improper maintenance.”

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