Knowles backs continuation of SB 21

Believes tax change needs time to work; concerned about state taking 25% equity share in LNG project because of amount of money

For Petroleum News

By STEVE QUINN

Former Gov. Tony Knowles says he believes it’s time to leave the new gas tax alone. Knowles, an Anchorage Democrat, left office in 2002, after a two-term stint as the state’s seventh governor, and has remained actively interested oil and natural gas issues driving Alaska’s economy.

While voters hit the polls in August to decide whether to repeal Gov. Sean Parnell’s tax plan, Senate Bill 21, Knowles has backed those fighting the repeal.

He faces pushback from those pushing the repeal who alleged a cozy relationship and being a paid shill by with the oil industry.

Knowles said he was never paid and had never received any money from the industry since the 1960s when he worked in the Cook Inlet and North Slope oil patch.

He received an apology and has held strong on his position: SB 21 needs to be given time to work; any changes need to be small and necessary, but not wholesale.

Knowles spoke to Petroleum News about his position on oil taxes and the prospects of Alaska marketing North Slope gas.

Petroleum News: There have been different oil tax versions backed by different Legislatures. Do you think this has hurt the state or are we just trying to find a balance?

Knowles: Well, let me maybe try to explain what I think is the overarching policy that should govern various tools - and taxes are certainly an important part of that. While oil taxes in detail are quite complicated in detail, our policy is quite simple in what should drive it.

Alaska is in a unique position to benefit the general public because it owns the resources. In owning the resource, which is unique among any of the 50 states in America, we are able to develop it as an owner and we also, as a sovereign state, will be able to benefit from taxation.

We want to make sure those policies are in alignment. We negotiated with a competitive bid that brought the state a lot of money for oil companies to develop the resources. We not only got the money from the competitive bidding, but we also retain in general about 12.5 percent of the oil for our ownership share.

In having that, it of course is the basis of the $40 billion permanent fund that we have as well as a significant source of revenue to the state. The other role that we have is that we have a regulatory role to make sure the fields are developed safely and most efficiently, then we have the sovereignty role in terms of taxes. There is the production tax, as well as the corporate tax and the property tax.

How we should develop the policies that make this of the optimal value to Alaska shouldn’t be determined by political slogans. Like you are being “anti-business” or you are “selling out” to the oil companies or this tax is a “giveaway.” We have to look at the economics. The most important issue facing Alaskans today regarding the future oil and gas development has to do with ensuring that we get more oil production. We have to work with the tax policy because that’s really the only tool that we have to effect the additional production of oil to make sure that while it maximizes the current value, that it also gives the right kind of incentives industry to develop more oil.

Petroleum News: So what drove your support for change?

Knowles: I saw we clearly needed a change in our tax policy because for the last six years with the production dropping at about 5 to 6 percent a year, we were clearly going to the edge of a fiscal cliff that would be a disaster to the Alaska economy unless we were able to reverse and lessen the reduced oil production.

Given that, we also recognized that Alaska, with the 12.5 percent of the oil, we are the fourth largest producer of the North Slope. We don’t take any risk as a state. We are the only producer that I know of that has never drilled a dry hole. We don’t provide money for maintenance and upkeep or development of infrastructure. Yet we belly up to the ATM machine every time a barrel of oil gets produced. We are in the cat bird seat in that sense as a producer because we pay no expenses and we collect all the benefits. We look to the oil companies for taking the risk and making the investments.

That’s where it’s a careful balance. The current issue over what tax regime that we have and what signals it sends has to be judged as a balance. If you look at the tax structures over the years, there have been changes. I would call them marginal changes that came with time depending on factors that the state has determined would be in the best interest of the public but also continuing to encourage the investment. There has to be an upside for the oil companies to make those investments. The most dramatic change was the ACES bill, which placed Alaska in terms of the marginal taxation of new oil the highest in the nation. We were ranked by any number of entities in terms of competitiveness and with other areas not only in the United States but internationally we were the least competitive. That’s what we were faced with. That’s what I think people need to judge today in terms of what is the best policy that we have given the limited tools that we have that will get us to the single most important goal and that is oil production.

We should also make sure in our analysis that we take a look at the other factors other than state revenues for the health of our economy. The other factor people need to judge is what tax regime is going to promote jobs for Alaskans and this is on a promote sustainable basis. What tax regime is going to promote the greatest stability for our state budget which affects the economy but certainly affects the critical services that we have: education; public safety; transportation, etc.

That’s the basis I think people should look at this referendum: a change from a tax passed to make Alaska more competitive back to a tax system that clearly had put a chill or put the brakes on additional investment, and was leading us astray, even though it was disguised by high oil prices and more jobs disguised by the increased maintenance, but those are not long-term sustainable, the kind of jobs that would increase our exploration and production.

Petroleum News: The prevailing argument right now on television and the Web seems to be this measure is about jobs. During the debate in the Legislature, it was about increasing production. Has the focus really changed?

Knowles: It’s clearly both. We are talking about the long-term sustainable jobs and also the connection of the health of the oil patch in terms of how it will affect the development of a gas line. Oil and gas fit together in the vision of the future. It’s jobs but it has to be jobs oriented to producing more oil. We know we have the resource. I don’t think anyone disagrees with that. What we have to have is the investment. As I say, Alaska doesn’t invest it. That’s not our position. Nor should it be. That has to come from the oil industry. We look at the 50-plus years of history our state has had, and we’ve had a balance, I think, whether there has been incentives for the development of oil and gas. At the same time, the people of Alaska have greatly benefited not only from the royalty but also the production tax. That’s changed over the years and it will continually be changed at the margin. But it always has to be looked at with the oversight in that we have to be competitive in terms of getting investment dollars to produce more oil.

Petroleum News: So why do you support SB 21? Is there anything there that stands out that will help advance the state’s interest and not just the treasury?

Knowles: it clearly did away with the extreme progressivity in ACES, which taxed at the margin with the high price of oil 75 percent. We clearly saw it put a chill in exploration and future production. What SB 21 does is it increased the minimum based tax of the next profits to 35 percent; ACES was 25 percent. That’s reflective of the fact that while we provide incentives on the upside by decreasing the progressivity, we traded it for if the price of oil drops, then we have a higher base minimum tax. My own personal experience, the price of oil can drop. When I was governor it went from $20 a barrel to $9 a barrel. Now that may be distant memory or history for most people. The one thing we know is oil can have dramatic changes up or down. The state’s many interest as a passive owner, since we do not take the risks and invest money, is to play it on the safe side and protect the stability of our revenues with a higher minimum base tax.

Petroleum News: The debate over oil taxes doesn’t seem like it will ever end. What do you make of that?

Knowles: In the SB 21/ACES debate there are a couple of issues that have been settled. One, there is no $2 billion giveaway. Scott Goldsmith from ISER at UAA has clearly shown that the giveaway to the oil companies touted by the referendum supporters does not exist. In today's market condition there is little difference in state revenues from either tax regime. Two, experts agree that the most likely near-term movement of transportation and production costs growing at a faster rate that oil prices will mean that SB 21 will probably raise modestly more state revenues than ACES. However this is not the most significant reason why we should retain SB 21. The real issue is the current and long term jobs and economy for Alaska, which depends on the ability of SB 21 to increase the exploration and production investment which will increase the total production of oil. We know the effect of ACES after six years of dramatic decline in production. SB 21 appears to have changed that direction. Oil company investments are up, jobs are up, and history shows that will result in more oil production. It deserves a chance to prove that point.

Petroleum News: This report gained a lot of pushback, in part for lacking a peer review. Why do you back Goldsmith’s work?

Knowles: There is no economist in Alaska that can come close to matching Scott Goldsmith's credentials and publications on the wide spectrum of the economics of Alaska and public policies. At the University of Alaska Anchorage and its Institute of Economic and Social Research he has authored over 350 research academic papers on these subjects over three and a half decades. While I was governor, Scott authored and provided invaluable public research materials on the topic of constructing a long-range sustainable fiscal plan for Alaska. He is universally regarded as a brilliant economist who provides independent well-researched documents on the economic analysis of public policy. I have known him personally for many years and highly respect his integrity and the quality of his work.

Petroleum News: There are some, even in the majority caucuses who believed change was needed but SB 21 went too far. Is that possible?

Knowles: There are different opinions on it and I think what we have to do is work with this new law. I know it’s disputed but there is evidence being given that it’s encouraged more investment. Conoco has doubled its investments in the last year and a half; BP likewise; ExxonMobil with all the commitments at Point Thomson. That should be closely monitored by the administration and the Legislature to see if there needs to be any changes. But they would be minor changes with a certain amount of stability the industry can see. The industry needs stability because it takes up to 10 years for a project to be envisioned, put in place and actually get more oil. They are looking at a horizon much further than just next year’s budget.

If there are things that need to be changed with SB 21, I know there is confusion over what new oil is that gets credit for being new oil. That’s going to have to be ironed out. It can be done through regulation if necessary through statute without overhauling the whole mechanism and going back to a system we know didn’t work. Even the proponents of going back admit that ACES didn’t work. What we should do to promote that sense of stability that is necessary to get the billions of dollars and investment that need to be done, we should look at what we have now, see where problems come up and make adjustments accordingly.

What we need is not political sloganeering, but a strategy to have the best business relationship. We know the oil companies, they have business goals and we want to try to bring them in alignment and that’s what I think is the most important relationship. As we look back in history, that’s where it’s worked.

Petroleum News: On to natural gas and a pipeline. Your administration created the Stranded Gas Development Act. Since then there have been plans that failed at various junctures. What do you think is holding this back? Is it the market? Is it politics? Is it a bad blend of both?

Knowles: What drives natural gas is the market. When I was governor, gas was about $2 an mcf. Then it spiked and it went up to $8 and $10 an mcf and that generated a huge interest in developing a gas line, but that gas line, it was felt, had to go from Alaska to the Lower 48 because that was the market. The foreign market was hesitant to look at natural gas, certainly in the volume and long-term commitment that is necessary to finance a multi, multi-billion dollar contract. You couldn’t use a small amount to finance a large-diameter pipeline. If Tokyo Electric wanted 750 mcf a day, well, OK, where are you going to sell the other 3.5 bcf a day? That’s why the foreign market didn’t seem feasible. Fast forward to where we are today. The spike in the Lower 48 gas prices has collapsed with the renaissance of the shale gas. We are now looking at exporting LNG where a few years ago everybody was predicting that we would be relying on imported natural gas just as we did with oil. The foreign market remains very high in Japan and the Far East, somewhere around $14 to $18 an mcf, and if there can be worked out a long-term marketing system, that’s what’s going to make it work.

I applaud the work being done on it by the state and the producers. I think it probably will happen and should happen, but the market is what’s going to drive it.

Petroleum News: So is the state on the right track?

Knowles: With one caveat. I think something that I share what has been expressed by a lot of people, is real reservations on the 25 percent ownership being put on the line. I don’t think there is enough information about that. It’s a huge amount of money. We know the risk that is in a project of that size, with that much gas and that long period of time. The profit margins for natural gas are so much smaller than they are with oil. I don’t think there is nearly enough understanding of real risks for a large state ownership in that project. It certainly is in complete reversal from day one for all of the state’s policies in oil. There are reasons why it would be a lot more attractive to oil than natural gas. There is a cautionary note.

If we have a stake in the project, we certainly need to be a strong advocate. In terms of sitting down and writing a check for $15 billion, that’s a whole different story. I don’t have any philosophical opposition to it. I look at the traditional roles of private sector risk in investment and the state’s traditional role as an owner having a royalty share of it, just like we do with the oil, but in terms of going out and negotiating a contract, drilling the wells, building a pipeline, taking the risk in a market collapse, that’s a whole different story.

People ought to think about this. The development of a gas line and the raw economics of project depend on the competitive price of natural gas, which is dependent on using the infrastructure of the oil development, because when you discover oil, you discover gas. You build infrastructure in terms of the development of it, which will in effect be a zero cost for the gas up to the point where it enters the pipeline. If we don’t have a robust oil patch, if we have a declining oil patch which is in a going-out-of-business-sale type approach, then there will be very little encouragement for the industry to put up the necessary money to build the gas line and develop that project.