Hoffbeck: Tax credits need further review

Revenue commissioner says oil and gas tax system not broken, but state cannot sustain credits in chronically low-price environment

STEVE QUINN

For Petroleum News

Department of Revenue Commissioner Randall Hoffbeck says the state’s current tax system isn’t as broke as some would have others believe. But it’s not as stable as it could be, either, particularly in the tax credit sections. Hoffbeck says he’s hoping the right changes - as opposed to emotional, ideological offerings - are made so the state has a more durable system that won’t need any tweaking for years to come. Hoffbeck offered his view of the tax system and some features of the fall revenue forecast one week before lawmakers gaveled in Jan. 17.

Petroleum News: What’s your overall assessment of the state’s tax regime, its strengths and weaknesses?

Hoffbeck: One of the things I think a lot of people miss is the gross tax and the impact it really has on the net tax. When we are at $50 a barrel, the tax is close to 70 percent of the net with a 4 percent gross. That changes pretty dramatically when you get above $50. With these prices, there isn’t a lot of money for anybody and I think sometimes the conversation causes a lot of political rhetoric and people don’t recognize just how strapped everybody is at these prices. At these prices, we are collecting about as much as is a reasonable amount to collect. Some would argue too much. I don’t see a lot of issue with the tax itself.

The credit is more of a problem: The open-ended credit program at these prices where we are not generating enough revenue to pay the credits yet we are still accruing the liability. That is where the biggest issue is at these low prices. There is some argument for a higher gross tax or less of a per-barrel credit as we move up to allow a little bit more revenue for the state. That’s a good debate to have. At the upper end, that was purposeful to reduce the state’s take at the upper end. ACES was seen as a little bit of an overreach and had to be pulled back a little bit. I think there is general consensus on that. I think there is some room for movement in the middle areas potentially: lower prices there is not a lot of money for anybody, upper prices think it’s pretty solid where it’s at.

Petroleum News: Have you considered modeling the current tax system at extremely low and extremely high prices so people can get a broader view?

Hoffbeck: We have. In fact there is a new chart we have used a couple of times in meetings late fall and early winter that really lays out what the actual severance tax take is all the way essentially from $20 a barrel to $200. Once you get above $160 it’s 35 percent. Anything below that it’s something less than 35 percent. It’s about a 10 percent rate where it goes into the gross tax, then it goes into new operating loss.

We’ve got it modeled. I think it will be part of the discussion this year. We really want to take a lot of the noise out of the discussion and have people just really look at the numbers.

Petroleum News: Let’s go back to tax credits. Are they too costly or are there too many of them?

Hoffbeck: The numbers have been dramatically reduced with what they did last year in Cook Inlet and the expiration of credits on the North Slope. We are really dealing with the net operating loss credit. It’s that open ended expense that we have no control over. They come in two flavors. We’ve got the reimbursable credits for the small producers, or the developers. That liability accrues regardless of oil price. Then you’ve got the net operating loss for the producers which only accrues if oil prices are below the high 40s. So it’s really only the small producers and the non-producers are generating those cashable credits. It’s kind of self-corrected on half of it although we would like to get that fixed so that if we do drop back to the low price environment in the future, we don’t have these net operating loss credits that can drive the severance tax to zero.

But, it’s not quite as imperative as it was because the price recovered, but the cashable credits for the folks developing fields - that’s still a huge potential liability. If you get a $10 billion development like you can have in Smith Bay, all of the sudden you’re on the hook for $3.5 billion in credits and we have no revenue to pay those kinds of credits. We’ve got to have something that gives us control over those credits in the long run.

Petroleum News: Have you been meeting with industry players these last several months?

Hoffbeck: We have. The governor has met with them more than we have. Last summer (2015), Ken and I and Pat and some others, were doing a lot of leg work, but the governor this year has done a lot of the meetings himself to try to elevate the discussions to get people we need in the room to reach some resolution. So yeah we have been meeting and we have tried to stress to people the importance of coming up with a solution this year. The way I laid it out with them is right now we are paying credits with money from the CBR but if we bleed the CBR this year and we have to start paying credits with Permanent Fund earnings, I don’t think the public is going to be very receptive to that. We’ve got to a point where we’ve got to get if fixed this year.

Petroleum News: in the past you’ve held town hall like meetings. Do you see that happening again?

Hoffbeck: I do. I did a couple of them this year. It was more along the lines of a broader fiscal plan. Oil and gas credits are part of the discussion, but it was more of the broader discussions. As occasions allow, we will do that more in the future. We want to keep the public engaged in the discussion. I think for the most part the public is pretty much aware of the issue we are dealing with.

Petroleum News: Getting back to the industry people for a minute, have you met with people who are already here or those we are considering coming up?

Hoffbeck: It’s primarily folks who are already here. I think all the new players we met were last year. I don’t think I met anyone who is considering coming up here. I guess that’s not terribly surprising because people aren’t really expanding during this low-price environment.

Petroleum News: On the credits, then, any idea how you’re going to be able to pay down the back tax credits which is about $500 million right now?

Hoffbeck: Really three alternatives right now. One is the governor has proposed in his budget, which is essentially what he did last year with the veto, which is paying the statutory minimum. We will eventually whittle them down, but we won’t whittle them down if we don’t get some control over new credits that are developing. If we can get that under control and we would hope some of these fields come into production.

The second option is what the governor proposed last year but didn’t get passed, and that’s if we get a whole fiscal plan in place then we can pay off all the credits. We’ll wipe the slate clean with one lump sum appropriation from the CBR. The other is the Legislature does what they have proposed the last couple of years, which is some level of payment but less than a full payoff. Either that one or the full payoff is going to require a full fiscal plan. Without a full fiscal plan in place, we won’t be able to pay more than just the minimum.

Petroleum News: How do you prioritize? Is it first in, first out? There is a provision for local hire kicking in soon, correct?

Hoffbeck: It still first in, first out. With the legislation passed last year (HB 247) there was a provision in there that has a local hire priority that gets laid in on top of that first in, first out. We’ve got $500 million that are first in, first out that were accrued before the new statute so it will be a while before the local hire would come into play. Once those credits are paid down, the local hire would be first in, first out. After that, it would still be first in, first out but on the first out, they would be prioritized by local hire.

Petroleum News: Right now the administration doesn’t have any bill on oil tax credits so what kind of discussion do you expect to have?

Hoffbeck: I’m sure we’ll come to some resolution to see what oil and gas tax bills others may introduce. We are hoping to work more cooperatively with the Legislature this year. Last year we just introduced everything and then tried to carry a massive number of bills. We are hoping certain legislators will take on certain issues. Then we can sit back more in a support role or in an information role, then let either the House or the Senate carry the bills through. So depending upon whether the House or the Senate introduces anything on oil and gas taxes or credits will dictate whether the governor introduces a bill or not, but if they don’t introduce one I fully expect the governor then would eventually put one into play. It’s important that we get that credit piece under control.

Petroleum News: Why do you think you came up short on HB 247?

Hoffbeck: I think there was a lot of concern on the North Slope that a credit package similar to Cook Inlet would impact some fairly high-potential field developments. With Cook Inlet, the issue was energy security for the major population centers for Alaska. The credits worked. The gas was discovered. The fields were online. There wasn’t a lot of reason to keep the credits in Cook Inlet. People felt more strongly with the Repsol, Armstrong and then of course with Caelus in Smith Bay, they felt there were some fields that needed to have some support and they weren’t willing to take as big a bite out of it as they did in Cook Inlet. And quite frankly, Armstrong and Caelus did a pretty good job of lobbying the Legislature last year. The Legislature moved about as far as they were willing to go last year. I’m hoping they will be will be able to move just a bit further this year and we can get that new operating loss credit under control.

Petroleum News: Through your various roles throughout the state, you’ve seen how the oil industry affects the state or the borough you’ve worked for. You’ve seen enough changes in tax regimes, so why is it so difficult to get a stable tax regime?

Hoffbeck: That’s a good question. When we came out of ELF, the work done in Gov. Murkowski’s administration to create PPT was driven largely by the numbers and that ELF over the years had broken down. It wasn’t working anymore. There was the idea that if we have a net tax, we can incentivize developing more expensive fields. There were a lot of reasons to go to a net tax. It was pretty well thought out. ACES was a reaction to the corruption issues that surfaced in relation to passing that bill, so it swung too hard against industry.

The pendulum swung back really hard when industry pushed back against ACES. I think we’ve got one more move to get it in the middle where it can be more stable. I think everybody wants it to be stable. But it’s got to be something that enough people on both sides think it’s fair enough that it doesn’t become a campaign issue or they just feel it’s unfair enough that they have got to change it.

The other issue is we became so dependent on oil and gas revenues over the year that we kind of came to expect that they would always pay for everything. Now the reality with low production and with low price, they can’t pay for everything. There are some people who can’t get their head around it. There are some people who think there is enough money out there that we can go get it from the oil industry again. The numbers just aren’t there. Part of it is that it’s just a reality check of 30 to 40 years of a free ride. People are having a little trouble adjusting to the reality is the oil industry is not going to be able to support everything anymore. It’s taken a little while for people to get their head around it.

Petroleum News: Would you consider ACES and SB 21 an emotional reaction?

Hoffbeck: I think there was a lot of emotion on that. I think there was some failed analysis, too. I don’t think ACES really fully modeled the impact of high oil prices. I don’t think anybody expected it to run up to $140 a barrel and see what kind of impact that had on the government take. It was very obvious that SB 21 didn’t model low oil prices. It just wasn’t modeled low enough to figure out when you hit those outlier price environments. I think that modeling has been done pretty well now. Hopefully, people can smooth it out around the edges and make it a little more palatable. I think it’s a good argument and a good discussion to have. I know that there are several groups doing competitiveness studies to see how our tax regimes competes with other states, to see whether or not we are too high or too low.

I think we are moving to a place where it can sit for a significant amount of time and not be whipsawing industry back and forth. I’m not the industry’s biggest supporter; I’m not the industry’s biggest opponent. I just see them as our partner. We need to hold each other accountable. The state needs to treat the industry the way the companies treat each other. They all want to succeed, but they are going to hold everybody to doing their fair share. The state needs to do the same thing. I think we are close. I think we are close to being in that place. I think there is one more iteration out there before we get there.

Petroleum News: Let’s talk about the production forecast methods. You decided to use in-house personnel rather than consultants. What drove the change?

Hoffbeck: Two things. One is budget cuts. We were spending in excess of $100,000 a year for the Department of Revenue to hire a consultant to do production forecasting while DNR had in-house folks were doing the same thing. So do we need that redundancy? It was nice in past years to have the ability to double check everything. When we were looking at taking money out of the budget then it seemed reasonable that we could rely on DNR’s work. They have petroleum engineers. They have reservoir engineers. They have the capacity to make good forecasts. Secondly, when we looked at the information the consultants were using, which was publicly available data and looked at what DNR has, which is a lot of proprietary data, we were thinking DNR has better information. It just made more sense for us to look to DNR to do the work.

Petroleum News: How do you feel this has played out the first year?

Hoffbeck: We’ll see. I’ve asked DNR for a briefing to get a better handle on what they see for individual fields. My staff worked directly with them when they did the forecasting. I haven’t got that deep into the details of it. I want to get a better feel for it. The key is going to be just how on how quickly the fields have a negative response to the reduced investment that’s occurring right now. DNR expects a quick response and it shows up in their forecast. I think we were all surprised by the forecast for next year. I expected it to be a little higher than that. I challenged them on their numbers. They were comfortable on where their numbers are. If ever there was a fallacy in the forecasting the Department of Revenue did, in the mid-term it tended to be overly optimistic. With the DNR forecast it’s going to be a lot closer to what actually happens.

Petroleum News: So were figures too optimistic in previous forecasts?

Hoffbeck: A lot of it came from how they risked new field developments. There was always the issue of these are what the development plans say and this is what the reservoir modeling or the decline curve analysis said should happen. Assuming everything is going to happen the way it’s supposed to, this is how it should work out. But things never seemed to happen the way they were supposed to. There were development delays. There were corrosion issues. Things didn’t seem to happen quite the way people plan. I think in our forecasts of the past, we never really risked that sufficiently. DNR did risk things differently this year and I think that’s part of what you’re seeing.