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Dan Dickinson: ELF 101 Economic limit factor established by Alaska Legislature to protect marginal fields, Tax Division director tells Alliance ‘Meet Alaska’ Kristen Nelson Petroleum News Editor-in-Chief
Dan Dickinson, director of the Alaska Department of Revenue’s Tax Division, talked to the Alaska Support Industry Alliance “Meet Alaska” conference Jan. 27 about the economic limit factor, ELF, and how it relates to the $700 million dollars the state collects each year in production taxes. Of the $2.4 billion in state general fund revenues in fiscal year 2004, Dickinson said, $1.1 billion was oil and gas royalties, $700 million was production taxes and about $300 million was oil and gas property taxes and income taxes, plus some $300 million that is not oil related.
The framers of the legislation which established ELF “wanted to protect marginal fields,” Dickinson said. “They wanted to make sure that the production tax was not responsible for shutting fields in.” The Legislature knew there are costs associated with production, “and the framers of the ELF didn’t want the production tax to be another factor in shutting it in.” How production tax is figured The production tax base is the gross value at the wellhead, Dickinson said, which excludes the transportation costs of getting the oil to market. The framers of ELF, he said, decided “to create a proxy for (upstream) costs.” Instead of deducting those costs, the ELF is supposed “to shield a set of costs, a set of direct operating costs, from taxation.”
This gives the producer a base of barrels that are not taxed, “enough to cover their costs, and then the additional barrels get taxed.”
In 1989 the ELF formula was made more complex: “A field-size factor was added to the statute” redefining the proxy for cost. Large fields would pay a higher tax “and small or marginal fields would pay little or no production tax.”
The ELF is a number between one and zero that is multiplied times the production tax of 15 percent and times the gross value at the wellhead to determine production tax. Prior to the Jan. 12 aggregation decision, Prudhoe had an ELF of 0.8166, Orion had an ELF of zero, Borealis had an ELF of 0.0398 and Point McIntyre had an ELF of 0.0832.
Prior to the decision, three fields on the North Slope paid significant production tax: the main field at Prudhoe Bay, Alpine and Northstar, all of which, Dickinson said, have an ELF in the range of about point eight.
“Just last year we passed the point where half the barrels on the North Slope were considered to be below the economic limit … so half the barrels on the North Slope paid no (production) tax.” For 2005, 51 percent of barrels on the North Slope paid no production tax. By 2008 that number would have been 62 percent, and by 2020 it would have been 81 percent. Is ELF working? “Obviously some people would say that’s precisely what the framers had in mind: as the fields mature, the ELF should fall, the taxes should fall.”
But Dickinson said that as the division looked at it, they decided that wasn’t what the framers of ELF had in mind.
Consider Prudhoe Bay, he said, “a large mature field.” The ELF is high, point eight, Prudhoe is “considered a robust field, so most of the barrels are capable of paying tax.”
The small satellites, he said, pay no production tax as a consequence of ELF. “And what that is saying is all the production of that field is needed to cover costs.”
But look at how Prudhoe Bay and its satellites are produced, Dickinson said.
The producers at Prudhoe, he said, are trying to get as much oil as possible into the pipeline. To do that, “they’re going to use a policy that they call ‘best well produces,’” based on how much natural gas Prudhoe facilities can handle. The producers will look for the well that “has the most oil for the least gas,” he said. They will then look for the well that has the worst gas-oil ratio, producing the most gas for the least oil. The worst well is taken out of production; the best well is put on production.
What the Tax Division is found, Dickinson said, is that the tax system “says the older mature wells on the North Slope, at Prudhoe Bay, can bear lots of tax. But those wells are being shut in. Our tax system says that satellite wells, the new wells, can’t bear much tax, and those wells are being brought on in place of the old mature wells.
“In short, ‘best well produces’ makes the most sense commercially, putting the most barrels into the trans-Alaska pipeline, but it twists the basic premise of this tax system around and that doesn’t make any sense.”
That is why, he said, the division used the discretion it has under Alaska statutes to aggregate the fields at Prudhoe Bay for purposes of ELF: the main Prudhoe reservoir, Midnight Sun, Aurora, Borealis, Point McIntyre, Orion and Polaris.
“Those Prudhoe Bay fields are being operated as a single entity. The tax system makes sense when you think about them as a single entity; it doesn’t make sense when you think about them as separate entities.” Governor asks: are we competitive? Dickinson said the question the governor is always asking, “and he asked very much about this decision, is, ‘are we competitive?’”
Based on eight evaluations of competitiveness, “generally we’re considered pretty competitive … 90 percent of the places they looked at were less competitive; only 10 percent were more competitive.”
Dickinson said the studies were “very dependent upon price. … The higher the price, the better Alaska is to do business; in a low-price time we are not a very good place to do business.”
Prices also factored into the ELF aggregation decision, Dickinson said. Higher oil prices have persisted for almost five years, he said, and at high prices “clearly there’s a lot more revenue being generated to cover costs.”
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