French: ACES tax structure not broken

Anchorage senator says tax appropriate for harvest regime, with gross revenue exclusion to encourage investment, progressivity cap

Steve Quinn

For Petroleum News

Sen. Hollis French says the current oil tax system known as ACES isn’t broken, but he’s willing to make some changes. He and three other Senate Democrats drafted Senate Bill 50 as a counter offer to Gov. Sean Parnell’s SB 21. But it’s SB 21 that’s gone out of two committees and a committee substitute — or CS — is headed to the Senate Finance for a third committee review. Still French believes provisions of the minorities’ bill warrant a look. He sat down with Petroleum News to discuss his thoughts on changing ACES, a debate now in its third year of earnest discussion.

Petroleum News: What drove you to introduce your own bill?

French: You know, we felt very strongly that we had to have the Democratic offering in the debate and the only way to do that was file a bill. You can go through bill amendments and so forth, but the most traditional way, the most responsible way is to file a bill that embodies what you think oil tax reform should look like, so that was why we got the bill out and filed after seeing the governor’s bill didn’t live up to what we thought was the best policy.

Petroleum News: Last year you didn’t file a bill. You had a CS, but you didn’t file a bill. Is your bill saying in essence, there needs to be changes and that ACES is not working?

French: There is a big difference between saying we need to makes some changes and a bill doesn’t work. I was thinking about that. An analogy might say some people would go home and say the house needs cleaning up and clean the house. Others would say let’s take a bulldozer and knock the house down and build a new house. We’re are of the opinion that we can do some housecleaning on ACES and make some minor adjustments and make it work better in response to what we perceive are some legitimate criticisms. That I think is true of any tax code ever written anywhere in recorded history.

You can always make the system a little better. The governor’s approach, now the CS approach, is to knock at the foundation of ACES. I think the elimination of progressivity and the large reduction of credits available is proof of that. It’s really attacking at the foundation of ACES. We think that’s a mistake. I think that’s a mistake. Folks need to be reminded of the basic philosophy: if you are in harvest mode, if you are taking your oil tax profits out of Alaska, and reinvesting them somewhere else in the world, we are going to tax you at a higher rate than companies that reinvest in Alaska. If you invest here, you will buy down your tax rate and pay much lower taxes. That’s a very strong policy that progressivity and the credit elements helped create.

Here is a good example. (In SB 50) We put a cap on progressivity at 55 percent. That’s the highest progressivity can go now. I think it currently would go to 75 percent so we decided to put a cap on that. We did that in response to two issues. We heard over and over and over that we take too much at the high side. And we saw this perverse effect that the higher the tax rate grows, the greater the state participation in investment becomes. The state winds up assuming a larger and larger share. So we thought we can bring that down by capping progressivity. I think it’s a significant give. It’s not a concession that ACES is broken. It’s saying we can make the system a little more fair.

Petroleum News: So why wasn’t that done last year?

French: we came very close to producing a bill from the coalition last year. We couldn’t go far enough to get Republican votes to make it pass. What we did pass was stimulus for new oil. It was a bill that went out of the Senate, 17-3. It was at the end of session and a bit late.

That speaks to the complexity of the issue .If you really, really think hard about this, it’s a tough issue and a very complex one. We spend enormous amounts of time on doing basic research, collecting basic data, listening to lots of experts. We really did our homework. That drove home to many of us that it’s very complex. Out of that work, came one enduring aspect, which is the gross revenue exclusion.

That’s something that sort of emerged late last session and has become a fairly popular idea. The governor liked it enough to put it in his bill. The committee took his 20 percent GRE and pushed it to 30 percent. The Democratic bill put it at 10 percent. It speaks to the amount of work we’ve done and the innovations that can come if you work hard enough.

Petroleum News: What do you want to hear from the industry that will enable to support a change?

French: From my perspective, I think it’s hard to have an open and frank dialogue with the industry on taxes. The position they have to take out of a duty to, loyalty to shareholders is the tax rate must always be lower. That is just the structure of their enterprise. I appreciate it. I support it. I have a BP retirement from my years in working on the North Slope, so I get they have to make a profit. It’s hard to have a frank conversation about what tax terms they need because they have to ask for more just by the very nature of their mission. The better conversation is between the Legislature and the administration.

Petroleum News: OK, so what do you want to hear from the administration?

French: I was just looking at a letter I got back from Revenue. The single most important question I have is quantify the number of additional barrels of new production it will take to offset the cost of lost revenue under SB 21 and at three different price points: $90 a barrel, $100 a barrel and $130 a barrel. Frankly they didn’t answer the question. I’m going to have to start doing my back-of-the-envelope analysis so that I can come up with some numbers so that I can at least tell the public what it is we are giving now, what is it in the future we are going to get in exchange for this. Quite frankly, I’m worried this bill never is going to pencil out and it’s going to be a revenue loss for the state in exchange for something. It may return more to the oil industry or their employees, but not to the citizens. I want to put some quantifiable number on that.

French: That is what we need to find out. Some sort of revenue loss might be $5 million, $10 million, $100 million, $500 million or a $1 billion. You’ve got to be able to nail that down. People in the Legislature have gotten far too accepting in throwing around big amounts of money without stopping to think what the real world implication of that is.

I’ve always used the cost of building a brand new high school as a way to keep numbers in perspective. In Alaska the cost of building a brand new high school is $50 million to $60 million. So that helps you know when you’re talking about $200 million. Those four buildings would make a big difference in our education system.

Petroleum News: If your bill doesn’t get a hearing, what’s the alternative?

French: (Monday) I ran four amendments to the CS. The first was to replace their CS with my bill. So there is a way to use a platform of the bill to get your ideas in front of the body. One idea is going to get more traction is limiting the gross revenue exclusion. My number was seven. Ten might be a better idea, but I think I’ve got the attention of some of the finance members, so it might be debated more at the finance table when the bill goes there.

Petroleum News: Let’s talk natural gas. What are your thoughts on the status on advancing a pipeline project, either a large line to tidewater or the in-state line?

French: They both ultimately are challenged by the market. The Lower 48 market, of course, is dead to any import of gas from outside the Lower 48, so that’s been foreclosed. Everyone is turned to bringing a pipeline to tidewater in Southcentral with no specific location terminus identified yet. The small line is always going to be challenged by its economics. It’s going to be hard how you can bring gas 600 miles to tidewater and beat the price of gas from your backyard in Cook Inlet. That’s been my working assumption. As far as the big pipeline goes, I think every time we hear the price has gone up another $5 billion or $10 billion, you need to sit back and gasp at the size of it and wonder if it works into the world’s demands. Someday a big pipeline will be built. I believe you will want to build the biggest pipeline possible and do it once. Do it right the first time. There is too rich of a resource and our system is stable. The basic infrastructure is there for most of the route as far as right of way goes. So it’s going to happen but it may be down the road a little bit longer.

Petroleum News: You talk about the small line and Cook Inlet gas. Do you think you’ve got enough information to believe there is enough gas there to supply the Anchorage area?

French: I have been putting in a huge amount of time in that area. I’ve read the PRA (forecast) studies; I’ve met with folks from Enstar and from CIRI and from the utilities; I’ve spoken to Sen. Micciche about the export facility. The best idea I have so far is increase the amount of storage capacity so there is a market for the new gas wells being drilled. Without an export facility if you create more gas than there is a market, you can put it in the CINGSA facility, but once that’s full you’re done, and it’s bad to have gas wells throttled back in the summer when demand is low because the gas wells don’t respond well to being cycled that way. You want them to flow as hard as possible year round. I’m working on trying to stimulate another storage facility. I think that’s comfort for the Southcentral region to have got a bunch of gas in the bank just like you’ve got a stack of wood in the summer to burn in the winter.

Petroleum News: Do you have any faith in the Asian market helping?

I don’t have any reason not to believe. I’ve heard there are Asian buyers ready to buy our gas. But the soonest you can get our gas to market in Alaska is 10 years from now. As pleasant sounding as those promises are, I don’t know they are sufficient to build a pipeline. I hope I’m wrong. I hope some Japanese buyer steps up and says I’ll take gas at the wellhead on the North Slope at a price that the producers like and they start building a pipeline.

Petroleum News: Do you think a larger line could be advanced if the state began negotiating long-term fiscal tax terms?

French: That has always been their position — that they need fiscal terms in order to get there. I understand the economic difficulty from their positions to spend tens of billions of dollars on a construction project and be open to a tax increase during that time. I think we did the best we could under AGIA. We offered 10 years of no tax changes for the gas that’s put in the line upon first gas. Our constitution, on the other hand has an explicit statement that says the power of taxation shall never be surrendered. It’s there for a reason. So you’ve got a constitutional mandate against the economic fears of the producers. I think we balanced it out as best as we could.

Petroleum News: Do you still have faith in AGIA? You were one of its strongest proponents.

French: You know it was the way forward at the time. I haven’t seen a better idea yet. It stalled out because of the conditions of the market. Frankly it’s a good thing. Some people say we missed the gas window. When they talk about it they talk about a gas line overland into the Lower 48. I thank goodness we didn’t do that. We would have been delivering gas to the weakest market in recent memory. What a calamity that would have been! The gas is still in the bank. We haven’t made a mistake yet. We’ve saved ourselves from not getting a pipeline overland to Canada.