Coghill: Tax systems warrant scrutiny

North Pole Republican says state needs to be prudent with credits during austere times, but any changes must be forward-looking

STEVE QUINN

For Petroleum News

Senate Majority Leader John Coghill has been through numerous debates on oil taxes and credits since first being sworn in as a member of the House in 2003. Each, he says is warranted, even though some say it makes the state look unstable.

The North Pole Republican spoke to Petroleum News about the current discussions over the state’s credit system and Gov. Bill Walker’s efforts to harden and raise the minimum tax to 5 percent while scaling back credits.

Petroleum News: We’ve had several changes to the oil tax system in the last 11 years, granted some favorable to the oil industry, so why do you suppose we are back here talking about changing oil tax credits and even taxes themselves with hardening the 4 percent floor?

Coghill: Well we know we have a good resource and we know we have to raise an income stream for Alaska out of that resource. We also know that we have to play in a market that is internationally driven and we have very little control over that. We went from investing into our oil industry in Alaska to trying to incentivize them to spend money here, which I think we did. That part was successful.

But under the ACES to SB 21 days, we realized that incentivizing spending didn’t always get the benefit that we were looking for and that was new exploration, a broader field of participants and better outcomes as far as the industry goes. So we went to a production based tax that rewarded production instead of spending and that was a difficult lesson. We had some of the best consultants in the world talking to us about that while the whole world was going through a change.

If you remember correctly, at the time we were going from PPT to ACES, we were going through the final throes of acquisitions and mergers of private oil companies internationally and the rise of national companies in a huge way. We were on our way to a market that was overheating and we had no idea where that market was going to go. Our tax protected us on the high side. For the most part we wanted to make sure we shared in the wealth on the high side and still incentivize things.

We increased the spending in our fields but our production was not keeping pace with what was going on around the world. The investments had changed dramatically. Right in the middle of that debate we come into the fracking world. That had a huge impact on a couple of things: the way we treated oil and the way we treated natural gas.

Both of those things had a dramatic impact whether you want to talk about shipping it down the TransCanada model or trying to export it by LNG, so the ACES issue and the TransCanada pipeline were kind of wrapped around each in many ways with great expectation from resource investment.

The best people in the world were investing in LNG imports if you remember correctly. So we were expecting to be part of the natural gas market as well as a continued oil field. We knew we had to diversify our oil field basin which is primarily an oil field with huge natural gas reserves, which could be good for America if they were thinking of importing natural gas.

The dynamics of that changed probably within an 18-month period and during that change, we realized our tax system could not respond to those changes.

We needed production to increase and we had to re-set how we thought about our natural gas. So Parnell came into office facing that and talked about increasing production the best we could and trying to get a pipeline to work. We set out an aggressive plan to include the oil companies that finally became an agreement they would move forward on AKLNG.

We still wanted to diversify the market off the North Slope, but while we were doing that natural gas went from $8 an mcf all the way down to $1.50, and we went from $140 a barrel to $110 a barrel down to $95 a barrel down to $75 a barrel all the way down now where we bounced off of $27.

Petroleum News: So that’s where you’re at now? What has your attention the most?

Coghill: Well, this is where we began to focus on the floor of our tax. Is that surprising? When do we go negative? What we’ve agreed to do is invest in our oil fields by way of production tax credits and production taxes. We could have stayed at a gross tax and been fine, but to be competitive in the world and to draw people to invest we said we’ll set the tax rate high but we’ll incentivize high. If you do it here, and you get production you get a reward. So Alaska said we would invest in that field by taking significant parts to that. Now with oil prices bouncing way off the bottom, both the oil companies and the state of Alaska are asking, can we afford that rate of investment? The answer is no.

If producing oil literally costs you money to produce, but the infrastructure and the value of that oil is high enough to go through a negative valley, how much can the state be a part of that? How much can an oil company endure that? How many months and years can you endure that? That’s the debate that’s happening right now. I think the oil tax credits - whether it’s the Kenai or the North Slope - we are asking is the investment level Alaska made by way of credits and incentives, is that worth what we are getting now and can we continue at that rate? I think the answer is no we can’t continue at that rate but then if we pull back too far, do we do damage to an industry that already has sunk costs and they are in the negative?

That is going to be part of the balance of the discussion. We don’t want to do damage to the North Slope because that is still going to be a paying field when we get back into the positive side of the world. The gas fields in the Kenai area is for the Kenai Peninsula, the Anchorage basin and the Mat-Su, so that’s kind of a feedstock to the breadbasket of Alaska, so we don’t want to pull back and do harm to that.

We don’t want to give the oil companies more value than we can afford but we also want to have that value translated into the consumers at the most populous places of the state. Consultants will argue over where that level is. In fact, we have consultants tell us that the free market can handle a little less investment and it might costs the consumers a little more. We are debating on what that level should be.

In the Finance Committee, there is a bill that talks about how do we look at the floor of our oil tax; how do we look at the Kenai fields on having no taxes but significant credits to produce that field? We’ve drawn people in who invest that money. We agreed we would share that investment and now we can’t afford that investment. We are going to have to draw back a little but not enough to disincentivize those we’ve asked to come here and do that work.

Petroleum News: The issue with the 4 percent floor remains very contentious. The governor has asked to have it raised to 5 percent and hardened. Others don’t want to touch it.

Coghill: If you are losing money, paying extra tax seems very painful. So that’s how the oil companies see it. He says it’s a 1 percent increase. It’s a one percentage point and that translates into a 25 percent cash transaction. So they are going negative. They are having to pay to sell their oil right now. Their oil is still good. It’s still valuable. It’s just that it costs so much to get to market. They are willing to do that for while. So that’s their problem.

Our problem is we have agreed to pay credits for that oil to get that up. We said we’ll have a floor. Now their operating losses can eat below our floor. We are losing value. I think it’s important and probably appropriate to say how much of a loss can we take while you’re taking your loss? I think that’s an appropriate part of the argument. I’m not interested in raising their taxes, but I’m not interested in us incentivizing them and giving any more losses. As long as I think the loss is equitable to the field. Not equitable to Alaska. Not equitable to the companies. Equitable to the investment that we put into the field.

That field has to be able to get through what I call a very deep valley. We know we are going to get out of this eventually. It could be longer than we like. It could be more painful than we want to endure. We made that investment to get the oil up. It shouldn’t be more on the oil companies that it is on the state of Alaska. They are withdrawing some of their investment. They have to. They are laying off people. They are not drilling wells. They are taking down drilling rigs.

So the state of Alaska likewise is going to think where can we reduce our investment and still keep whole our field so that when prices go back up we have not done enduring damage. So it gets into the politics that oil companies are scamming us. Some people think that the people in the Legislature are too soft headed with any companies. If you step back four paces, that’s a tough field to improve. It takes longer to permit than any other field in the world. It takes longer to get it to market than any other place than North America, certainly any other place in the free world. It’s a tough place to do business but we have very good rocks.

We have the ability in our tax policy and our incentive policy to constrain or loosen up how that market can flow in a tough economic world. We took a little risk doing that. So did the oil companies. They put the cash out. We only put it in once the investment has been made. Whether or not we can afford to do as much as we’ve done I believe is a legitimate question. I really do.

Petroleum News: Now the ability to penetrate that floor with net operating losses caught a lot of people off guard. How do you feel about that happening?

Coghill: I think we need to look at that. If they can go into the negative, how far can we go into the negative with them? We allowed net operating losses to be added up and we can either cash them out or we can carry them forward to the day when we are making money again. I think probably a little bit of both is OK. They are putting cash into those fields already. Their loss is real month-by-month - real cash. I don’t mind being there with them because their investment into the field says it has real value. At the same time, we don’t want to pay them to be there, either.

So we want to match an investment, not necessarily carry an oil company: Finding that balance is no small task. When you have a floor tax it becomes kind of a gross tax. That gross tax then can be penetrated with operating losses, which none of us contemplated. When we put the tax in we were hovering around $110 a barrel oil with no idea that it would go below $70. We did not contemplate that. Just like when we put ACES in, we thought $98 would be the high end. Who would have thought $142 would be the high? Nobody contemplated that.

So for Alaska to get blamed for changing its taxes when you live in a market that is like a screen door in a wind storm - we are trying to adjust. I don’t find that disingenuous at all.

Petroleum News: As far as the floor being penetrated, some believe the lawmakers were aware of it and others believe it snuck up on them. What are your feelings?

Coghill: Everybody thought the 4 percent floor would be a hard floor. I remember some of the debate and the floor was meant to be hard. We did know and we were aware of the option for net operating losses, but we didn’t contemplate them being used. Our big problem was how would the credits be used, not how the losses would be used. It was just one of those things where it was not in the view. Some might say it was disingenuous. I think it was just a focus thing.

Who could ever think that that Saudi Arabia would be under water the way they are now? They are at huge losses, making Alaska look small. Who thought they would have to deal with their next door neighbor (Iraq) flooding the market? I think the prognosticators could only give you based on what they knew historically. We’ve entered into a new realm that had no basis in history. We’ll have to adjust. There is no doubt. What we are talking about right now is a credit adjustment. As you do massive tax policy there is always the benefit of hindsight that we could have done it.

But we have to look into the future. How are we going to do it from here on? The expectation is we are going into a rough, lean market. Five years ago the expectation was we were going into a very heavy loaded market that had no end. So we are riding a wave up, then we are riding a wave down. I don’t know what the long term look is. So with the floor, we wanted to protect ourselves, but the reality is we encouraged investment. Who would ever have expected we would be hitting the floor with huge loss credits?

Petroleum News: I know you’ve touched on this a few minutes ago, but do you think Alaska is unstable?

Coghill: Not any more than the rest of the world. We are dependent upon one industry enough that it’s the very thing we watch the most. We have to be able to adjust to a market that can whip through the international winds in huge ways. We’ve continually talked about for the last 10 years how to sustain ourselves through the years of our sovereign wealth.

We’ve talked about it since 2000. Never have we had the low production rate, the low tax rate and the high cost of government come to us in such a way as we have these last two years. We will have to adjust. Part of the adjustment is if we can’t afford the investment into our oil fields and nobody else can invest, then it has to be simplified and brought down to better basic economics.

We’ve had the ability to incentivize with more robust cash flow. When you have less cash flow, you have less opportunity to incentivize anything. So you draw back your investment and you let the market do what it can do. We know we are far from the market. We are high cost in the market. We’ve got good product in the market, but you have to get over the fence to get in the market to get them to buy. There are too many other players in the world can get it to market cheaper.

Petroleum News: What else are you seeing as you review SB 130?

Coghill: You know we are also living in an interesting change. It was about 10 to 12 years ago how we were talking about peak oil in a huge way. We were talking about how we were going to run out of oil. Because of the high cost of hydrocarbons and the peak oil doctrine, what you saw was the anti-hydrocarbon people had a huge move in the world. But now that the peak oil has lost its incentive because it looks like there is more hydrocarbons that we ever thought. The hydrocarbon is still politically anti-hydrocarbon for air quality issues, but it’s not as much as a cost factor any more. Between coal and oil, the hydrocarbon world has had a huge political push back. So your usage is down and your quantity is up, and you’re subsidizing the non-hydrocarbon industries. That transfer of wealth, how long can that go? America is not as heavily invested as Europe.

I’m saying all of this to say that I think our hydrocarbons are still valuable. The economics of (the late Venezuelan President) Hugo Chavez, Iran/Iraq and the hydrocarbon issue from the peak oil movements has had an impact on us as well. We are using less.

And they are still low costs. So is this an artificial market that we can endure. I don’t know. I don’t have the answer to that.