Capital is required to produce oil. At the corporate level capital is finite and capital is fluid. Capital will go where it will get the best deal. Thus jurisdictions and projects compete for capital.
The fiscal piece is a major determinant for profitability. Often fiscal costs can exceed development or production costs. Thus fiscal structure is a significant component of international competitiveness between jurisdictions.
Companies are willing to pay more taxes when the reward is greater (lower risk/lower costs/higher reserve potential). Thus in comparing fiscal regimes it is important to look at comparable jurisdictions in terms of operating environment, costs, risks, reserves, etc.
For example, if you were selling a 1,500 square foot house, you would not want to look at sales of 6,000 square foot homes to see what yours is worth. Thus Alaska cannot be compared, for example, with a low cost/vast resource regime like Iraq.
Thus in evaluating the adequacy of a fiscal system it is essential that you are comparing your fiscal system with that of its “peers,” those jurisdictions with similar environment, costs, risks, reserves, etc.
Alaska’s uniqueness (its operating environment, costs and distance from market) makes it difficult to find exact peers. However, one can find some similar jurisdictions in certain categories: for instance, there are 1) North American regimes, 2) tax and royalty regimes, 3) Arctic regimes and 4) jurisdictions with similar production/reserve characteristics.
Regarding the fourth category, Alaska produces about 600,000 barrels per day and has 3.6 billion barrels of proved reserves. (This is a DOE/EIA estimate based on confidential and mandatory reporting. Proved reserves are reserves that have at least a 90 percent probability of actually being produced.) For this exercise we found those jurisdictions that both produce between 500,000 and 1 million barrels per day and also have reserves between 2 billion and 8 billion barrels.
With the exception of category 3 (Arctic) many of these jurisdictions will have different operating characteristics from Alaska. In particular, most of them will have lower costs. In that regard we will actually be comparing Alaska with superior jurisdictions.
Based upon these four categories, we have developed a set of 23 jurisdictions that could be considered Alaska’s peers. (See chart, next page: some jurisdictions are in more than one category):
As has been discussed prior, the problem with the progressivity structure of ACES is that it creates high marginal tax rates at high prices, which creates high effective tax rates. This takes away a large share of the upside potential from investors. By upside potential we mean the potential to make a lot of money at high prices.
Upside potential can be very important in shaping investment decisions. Even though the upside may be of relatively low probability, investors can make so much money when it does happen that it can make the investment worth pursuing. But, if the upside potential is suppressed, the investors may not see enough profit potential to approve the project, and the project may not happen.
Figure 1 shows the comparison of effective tax rates at a market price of $120 per barrel for oil. Effective tax rate is defined as all taxes and royalties divided by pre-tax net income. It is the percentage of net income that goes to government. This includes all taxes and royalties.
ACES at 75 percent is clearly among the highest. HB 110 at 66 percent is also relatively high.
And these differences in effective tax rates are not trivial. Given Alaska’s cost structure and production volume, at $120 per barrel each percentage point of tax is worth about $170 million after-tax to the producers. (Current estimated upstream and downstream costs are about $32 per barrel. At a $120 per barrel market price that yields a net value of $88 per barrel. Production tax is only payable on the non-royalty 87.5 percent of production: $88 X 0.875 X 600,000 X 365 X .01 = $169 million.)
So for example, the 21 percentage point difference between Alaska (ACES) and North Dakota (75 percent vs. 54 percent) represents $3.6 billion in additional after-tax income to the producers. This is very significant.
Moreover, of these jurisdictions, besides Alaska, only Russia, Iceland, and Malaysia have progressivity. So at higher prices, which will have a bearing in upside potential, Alaska’s effective rate will increase, while the others’ (without progressivity) will not, making Alaska even more uncompetitive.
Of the four jurisdictions with higher effective tax rates than Alaska (Norway, Oman, Russia, and Indonesia) all have higher production than Alaska, all have higher reserves than Alaska, and all but perhaps the Russian and Norwegian Arctic have lower costs than Alaska.
Note that for Norway about 70 percent of production is owned by Statoil, 70 percent owned by the Norwegian government. So to a large extent the government is paying taxes to itself. Also, for Russia note that over half the effective tax is an export duty.
