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Providing coverage of Alaska and northern Canada's oil and gas industry
September 2022

Vol. 27, No.37 Week of September 25, 2022

This month in History: Let’s make a deal

20 years ago this month: BP says it wants fair, simple and predictable fiscal terms for gas pipeline from state; briefs DNR, Revenue officials on proposal

Kristen Nelson

Petroleum News

Editor’s note: The following is a reprint from the Sept. 22, 2002, issue of Petroleum News Alaska

BP Exploration (Alaska) Inc. has been saying for some time that one of the things required to make a North Slope gas pipeline project viable is state fiscal predictability. The state asked what that would involve, and in July BP began what it describes as a conversation with the state about fiscal predictability.

Bob Reynolds, manager of Alaska taxes and royalties for BP Exploration (Alaska), made the July 24 presentation to commissioners and staff of the Department of Natural Resources and the Department of Revenue. He and told PNA Sept. 12 that BP’s concerns about fiscal predictability for gas are grounded in the state’s oil history.

“The history of our relationship with the state on oil was that we spent well over a decade in very acrimonious litigation over essentially the tax and royalty terms,” he said. The companies ended up paying an additional $2 billion-$3 billion.

The gas project, Reynolds said, “cannot withstand that kind of risk.”

Fiscal certainty just one leg

But state fiscal certainty is only one leg of a “four-legged stool,” said Dave MacDowell, director of external affairs-gas for BP Exploration (Alaska).

Four things are needed to progress the project, he told PNA, and state fiscal predictability is only one. The others are federal enabling legislation, an efficient regulatory process in Canada and a reduction in cost for the project, now pegged at some $20 billion.

Since BP’s July 24 presentation to the state, the company has “been having conversations with people who have an interest in this topic”, MacDowell said, to inform people about BP’s view of fiscal predictability prior to the next session of the Legislature and the new administration.

BP asking for simplification

In evaluating fiscal predictability, Reynolds said, BP looked at all of the components of the state’s take - royalty, production tax, property tax, net profit share and state income tax - and asked how those elements of take could be changed to make them “more fair and simple and predictable” for gas.

The discussion BP had with the state was based on suggested ways to simplify the state’s “take regimes” for gas by using common terms between the different regimes and by calculating the value of gas just once for all of the regimes. In the present tax regime, different values are calculated for royalty and for production tax.

“In the new world we propose calculating one value to be used for both regimes, both the production tax regime and the royalty regime,” he said.

A lot of the conversation is about simplicity, Reynolds said, and “about taking areas that have historically been contentious either because they’re not well defined or not well understood” and agreeing in advance on “what we think are viable terms and then determining ways that we can test those terms over time.”

This was not a conversation about incentives or tax holidays or changes in royalty rate, he said: “This is just about trying to nail down what the existing take would be.”

Common terms

Simplicity is the primary thing BP is looking for in common terms, Reynolds said. With five different regimes in the state for taxes and royalty, “we have a large body of statutes or law and regulations that control each one.” In addition to that complexity, he said, there are also some omissions.

Reynolds said BP talked to the state about establishing an algorithm or formula to establish the value for gas based on available price markers.

And BP is also suggesting a different type of audit. Instead of auditing for compliance, Reynolds said, BP wants audits to validate the agreement between the producers and the state. “And if it doesn’t work, then we go out and we change the basic agreement.”

The test for clarity “will probably be whether we’ve minimized the areas of dispute,” he said. “If we can come away with an agreement that has some durability in terms of parties not wanting to break it, then we’ve succeeded.”

As for certainty, Reynolds said BP needs to run the economics on a 20-30 year project, and has to ask: “What degree of comfort do you have that those assumptions that you’re using are actually going to last that long?”

Determining a value

Common terms for taxes and royalty means one formula to value the product - for both tax and royalty, Reynolds said. What BP wants, he said, is “a value that reflects what we actually get for selling the gas.”

And that amount, MacDowell said, would be arrived at through an algorithm or formula, not by counting up each and every transaction. “And you could test that to make sure the formula was behaving as you expected it would.”

“We’d like to have our tax and royalty paid at what we get for our product,” Reynolds said. An algorithm or formula would be used to determine those net proceeds, he said: “Or at least approximate that.”

The algorithm would approximate reality, MacDowell said, without “the time, energy, effort and potential disputes” of measuring multiple transactions.

A “worst-case formula could be comprised of a hundred different markers,” Reynolds said. “What we’re saying is, let’s pick the most viable, most liquid, the most … transparent liquid markers and let’s use those.

“As long as they’re representative of what we think the real value of the Alaska gas is.”

“And choosing those, the most appropriate marker or markers, is the subject of the conversation that needs to occur with the state. That’s a critical part,” said MacDowell.

Deductions

Also on BP’s list are allowable deductions.

The gas treatment plant will be an “enormous multi-billion dollar facility” that is “essential to getting the gas to market” and BP wants the cost of operating that facility to be a deduction, Reynolds said. The gas treatment plant will be a regulated facility, he said, and will have a tariff, “and we would like to just make sure that that tariff is deductible.”

Another deduction, he said, would be for moving the gas from the North Slope to market. There will be a tariff for the pipeline, he said, and BP wants to use the regulated tariff as the basis for the deduction.

There have been many years of litigation over the tariff on the trans-Alaska oil pipeline, Reynolds said, and there are ongoing challenges even today to those tariffs.

“And what we want to do is make sure that we do not repeat that in the gas environment because the tariffs for gas are even more important to gas than the tariffs are to oil,” he said. The tariff on the trans-Alaska oil pipeline is about $4 a barrel and the value of oil is between $20 and $25 a barrel, so the tariff is 20 percent or less of the value of oil.

But, Reynolds said, a tariff on the gas pipeline could be $2 and the value of the gas $3 to $3.50 - a tariff of 50 percent or more of the value of gas.

BP wants to make sure that the state and industry don’t end up at odds over this, he said.

“We spent 10 years arguing about a cost that was less than 20 percent of the value of a product, oil. Without a change, what would that mean if you’re talking about a cost that was over 50 percent of the value of a product?” MacDowell asked.

To make sure that the state and industry don’t end up at odds over costs, “an agreement with the state will be required up front,” Reynolds said.

Fuel gas also an issue

Tax and royalty treatment of fuel gas - the gas used to run the treatment plant and the pipeline - is another issue that Reynolds said needs to be resolved. The normal practice in the gas industry is that the shipper donates a portion of his gas to the carrier for treatment and transportation.

“And we’re basically saying let’s do the same thing for Alaska. And that that gas that’s consumed doesn’t have any kind of tax or royalty associated with it.” Reynolds said that would be consistent with Lower 48 practice and also simplifies the process: the quantity of gas that is sold is the quantity of gas that is taxed.

BP also wants confirmation from the state that the carbon dioxide removed at the gas treatment plant and reinjected would be tax and royalty free.

Binding arbitration: winner take all

Resolution of future disputes is an important issue for the producers, Reynolds said, and the solution they propose is baseball-style (winner-take-all) binding arbitration.

“If we have a dispute, we call in some neutral third parties, present our cases and let them decide.”

The arbitration panel doesn’t get to split the difference in this kind of arbitration, he said: “It’s one side is right and one side is wrong.”

Oil royalty for the major producers is subject to baseball arbitration now, Reynolds said: “So we’ve been down this road and as far as we’re concerned it works.”

BP wants to see both tax and royalty for gas subject to baseball arbitration.

Only one check?

There is something else BP would like the state to consider, Reynolds said, something that is already done in Alberta.

If the terms for tax and royalty are common - same value, same deductions - “do we need to write two different checks? Why don’t we just write one check that covers both?”

That would be a big change, he said, but one the producers hope the state will consider.

Looking at an Alaska royalty of 12.5% and a production tax of around 10% for gas, an average would be 22-24%, factoring in some leases with a higher royalty.

In Alberta producers already write just one check: for 25%.

This would further simplify the state’s fiscal regime, and wouldn’t even be breaking new ground, Reynolds said.

Average weighted royalty?

BP is also proposing a single royalty rate for every molecule of gas.

Instead of saying so much gas comes from leases with 12.5% royalty, so much from leases with 16 2/3% and so much from leases with a 20% royalty, Reynolds said the idea would be to do a weighted average and charge all gas at one royalty rate.

BP is also proposing a uniform field cost allowance. Some lease forms allow the producers to charge field costs against the state’s royalty gas, he said, and some don’t. As with the royalty, BP is proposing a weighted average field cost applied to all gas.

Binding arbitration for property tax

On property tax, Reynolds said, BP is “not looking for a change in the municipalities’ take” but wants to see if it can reach agreement with the state on some of the components going in. It would make it a simpler task, he said.

BP also wants to replace the State Assessment Review Board with binding arbitration.

Reynolds said he doesn’t think either the producers or the state are in a position to deal with the income tax issue yet, but “it needs to be part of the final agreement” once more work is done.

The producers also want a moratorium on municipal taxes for the life of the project.

“We need to make sure on a project of this size that we don’t have municipalities applying things like sales taxes or transfer taxes or etc.,” Reynolds said.

Vehicles for delivery of terms

There are different “vehicles” to deliver these terms, Reynolds said.

One would be a contract negotiated with the administration and enacted by the Legislature. The constitutionality of such a contract would have to be tested in the Alaska Supreme Court, he said, because the contract would have to bind subsequent Legislatures.

Another possibility is something used elsewhere in the world: a compensatory royalty contract. Such a compensatory contract would say “if taxes go up by a dollar, royalty goes down by a dollar.”






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