Now attractive is Alaska for oil company investment? And how will the proposed changes in the state’s production tax — Gov. Sarah Palin’s Alaska’s Clear and Equitable Share bill, or ACES, now before the Legislature — change that attractiveness?
The Alaska Legislature has been told by administration consultants from Gaffney Cline that increasing oil taxes will make investments in the state more attractive to oil and gas companies.
Two other consulting firms, Wood Mackenzie and Cambridge Energy Research Associates, have released results from confidential studies of worldwide fiscal attractiveness which indicate the opposite. Under the petroleum profits tax enacted in 2006 Alaska was fairly far down in fiscal attractiveness for investment — at the bottom of Wood Mackenzie’s list. CERA also found Alaska fiscal attractiveness to be low and said the governor’s original ACES proposal, with a 25 percent tax rate, decreased the state’s fiscal attractiveness ranking.
Both firms provide confidential reports. The state bought the current Wood Mackenzie study for use by the departments of Revenue and Natural Resources and Wood Mackenzie has released a 38-page Alaska summary to all legislators.
ExxonMobil, a subscription client of CERA, paid for an Alaska report from its worldwide study and for David Hobbs, CERA managing director and vice president of research, to come to Juneau and present the Alaska report to Senate Finance.
Responding to commentsWood Mackenzie responded to comments made about its low ranking of Alaska’s fiscal competitiveness at the beginning of the special session by consultant Pedro van Meurs, brought to Juneau by the Legislative Budget and Audit Committee to provide an overview of how PPT was developed in 2006.
Graham Kellas, vice president of upstream consulting for Wood Mackenzie, told LB&A Chair Ralph Samuels, a Republican representative from Anchorage, in a Nov. 12 letter that its fiscal ratings are not based on whether taxes have changed recently, which was how he said van Meurs characterized the rating to legislators.
“The fiscal stability rating in the study combines assessments of both ‘recent history’ of fiscal changes and the ‘built-in flexibility’ of the current fiscal terms.” Kellas said those factors are weighted equally in Wood Mackenzie’s stability rating score.
“According to our analysis, Alaska was one of only nine regimes to adversely change the terms on existing assets in the study period,” Kellas said, noting the state added satellite fields to the severance tax ring fence under the previous production tax with its economic limit factor and then introduced PPT.
He said Wood Mackenzie’s study estimates that the state’s take from the remaining value of existing assets increased by $10 billion under PPT, compared to 2001 terms — the previous, ELF-based production severance tax. This represented “a transfer of 15 percent” of investors’ remaining net present value to the government, Kellas said. Under higher price assumptions — $75 per barrel — investors’ remaining value (NPV at 10 percent discount rate) is reduced by $21 billion, a 22 percent reduction, “compared to the NPV under 2001 terms.”
“We regarded the overall impact of these changes as a ‘significant increase in take from existing assets’ which is why Alaska received the lowest score on this measure,” he said.
Stability history issueKellas also addressed the issue of Alaska’s much-vaunted 16 years of tax stability.
Wood Mackenzie bases its “recent history” analysis on the end of 2001 through mid-2007, he said. While this may seem a short period, new investors are far more likely to be interested in recent government behavior than in what governments did in the 1980s and 1990s. “Investors are far more interested in how governments respond to significant shifts in the perceived attractiveness of investment rather than how they behave when the industry is in a steady state,” and oil prices were “relatively low but stable” between 1987 and 2001 “and industry and governments worked closely together to ensure economic development of discoveries,” Kellas said. Fiscal policies tended to be lenient, and some previously closed countries were open to investment.
He said Wood Mackenzie believes fiscal policies have become “notably less ‘investor-friendly’ around the world” since prices started to increase in 2001-02.
From the bottom upCERA’s Hobbs discussed with legislators how his firm does comparisons. In establishing a peer group the firm looks at sample field sizes, models how the fields would run under different fiscal regimes and then compares “the economic returns that can be earned in that situation.” In selecting a peer group, it looks at different environments and selects the peer group from those with “similar cost structures” — in the case of Alaska, high cost structures.
CERA assesses costs of developing fields under fiscal terms in place, the lead times — based on regulatory requirements and complexity of operations — and then compares “on an apples-to-apples basis, how does a dollar invested in those environments compare in terms of a dollar invested in any of the others.”
CERA found that “Alaska ranks near the bottom of that peer group in terms of the economical attractiveness of investment.”
Alaska’s production is declining and that decline is unlikely to be reversed “absent a fiscal stimulus that would make Alaska more attractive than competing regimes for investment.”
Attractiveness is also based on “the perception of stability, the growth potential and the ease of operations,” he said.
“In today’s environment, where cost of activity has nearly doubled since the start of the decade, the biggest shortage seems to be on engineering and project management talent and so for example return on effort might be as important a measure of the investment appetite as return on investment itself.”
ACES drops rankingHobbs said CERA found “that under the existing PPT regime Alaska is in the bottom half (of its peer group) and that depending on exactly how the ACES proposals are enacted, that that would reduce the attractiveness” based on measures in the study.
He said resource-holding countries are certainly looking at the possibility of increasing their take with current high prices.
But, he said, it’s easier to see the revenues “because that’s very transparent — and much harder to look at what is the underlying cost number, which is actually often far from transparent.” Because costs are not transparent, governments that have chosen to increase their take have “maybe a more optimistic view on the profitability of activities than is actually being experienced.”
One of the difficulties, Hobbs said, is “that activity levels are challenged by a shortage both of personnel to conduct activities competently and secondly by the relative attractiveness at a time of great cost inflation; companies are finding it hard to move forward, particularly with large investments, while they seek to tie down what exactly those costs will be and to limit their exposure to financial cost inflation during the course of the project.”
With fiscal terms increased — or under threat of increasing — “companies are seeking to make their investments in places where they can be most sure they will earn a return both in terms of having some assurance of fiscal stability but also in terms of having some assurance that their costs will also be controllable.”
Fundamentals don’t support priceOn the subject of current high oil prices, Hobbs said, “there is no doubt at all in our minds that the underlying fundamentals do not support a price as high as it is today.” The price may go higher, he said, “as the price is not set just by fundamentals but also by people’s perceptions of those fundamentals.” Remarking on the price spike in the early 1980s, he said “through the application of technology and through discipline in project execution,” industry cut costs of activities by more than half, “which in a sense was the reason the prices were able to retreat down into the 20s and even as low as $10 a barrel during that decade.”