A Citizen’s Guide

JUNEAU—Gov. Frank Murkowski’s oil tax reform bill has brought the day-to-day business of the House and Senate Resources committees to a dead halt as lawmakers try to grasp the implications of enacting sweeping changes to one of the state’s largest revenue sources.

The committees have been holding daily hearings since the governor introduced legislation last week to replace the current system, which taxes oil and gas based on the level of production, with one that taxes oil companies’ profits.

The governor’s proposed tax would take 20 percent of oil companies’ profits in Alaska after expenses. The plan includes a complex set of incentives designed to encourage investment and exploration by smaller, independent drillers.

While most observers agree the current tax system is flawed, many lawmakers are wary of the 22-page bill and the ramifications it could have on the future of the state.

“The hard part for us is we don’t want to go from bad to worse,” said Rep. Beth Kerttula, D-Juneau. “That’s why we have so many questions.”

The existing production tax represents a quarter of the state’s revenue from petroleum, which along with royalties and income tax on oil companies makes up 90 percent of the state budget.

Under the current tax regime, the state receives about 7.5 percent of the value of production. The governor’s proposal would effectively double the rate paid by most producers in the state, bringing in between $300 million and $1 billion in additional revenue a year, depending on the price of oil, according to the administration.

But the bill is heavily laden with tax credits and other incentives that have confounded many legislators.

The plan allows companies to deduct 20 percent of their operating and investment costs, while granting them an additional 20 percent deduction on capital investments.

Adding to the pressure of trying to comprehend the proposal, the governor has told lawmakers they must approve the bill before seeing the details of an agreement his administration has made with the major oil companies—Exxon Mobil, ConocoPhillips and BP—regarding potential development of the 35 trillion cubic feet of natural gas reserves on the North Slope.

Murkowski and the oil companies, commonly referred to as the producers, have cautioned the Legislature not to change the governor’s bill, saying that changes could mean a scuttling of the gas line. That rankles some lawmakers.

The governor’s oil bill has been met with serious examination in the Legislature by members of both parties. Roughly 60 questions—from the House and Senate Resources committees and from individual legislators—have been submitted to the administration in recent days and the questioning in the lengthy hearings has been intense at times.

“Getting this wrong would be disastrous,” said Fairbanks Rep. Jay Ramras, co-chairman of the House Resources Committee. “Either we get gamed by the oil industry and we leave billions of dollars on the table, or we run off the industry that is the basis for our economy. The right answer is somewhere between the two.”

Here is an overview of some of the top concerns that have come up so far and that may persist as the hearings progress:

THE MAIN CONCERN

Lawmakers are most concerned they’re being asked to vote on changes to oil taxes without knowing how it will fit into a development deal on natural gas.

Pedro van Meurs, the governor’s top outside consultant, has said the new tax rate won’t apply to gas development on the North Slope because the state is expected to take its share in gas instead of cash. But lawmakers are trying to figure out how the incentives in the oil tax plan would apply to the gas line.

“That could mean companies could deduct 40 percent of their costs to develop a gas pipeline from their oil taxes,” said House Minority Leader Ethan Berkowitz, D-Anchorage, and a candidate for governor. “That will cost the state critical oil revenue until the gas pipeline is operating.”

Under the governor’s plan, companies would be able to deduct whatever it costs to find and develop the gas but not what it takes to get it to market.

Simply put, companies can write off their costs to get oil and gas out of the ground, but they can’t deduct the cost of building the pipeline or the gas treatment facilities.

“We think that’s an incentive to build the gas line,” said Dan Dickinson, an oil and gas consultant to the governor. “But once the gas line starts up, we’ll collect severance tax on the gas.”

The administration says it’s difficult to estimate how successful the incentives will be in encouraging exploration, but its target is discovery of five new fields on the same scale as the 500 million-barrel Alpine field.

“Alberta and the U.K. made significant changes to their incentive rates, and both generated significant more investment that resulted in increased production,” said Chuck Logsdon, the governor’s spokesman on oil and gas issues.

WHY THE NUMBER 20?

One of the first questions lawmakers asked is why the governor chose a flat 20 percent tax on oil companies’ profits rather than another type of taxation system.

Logsdon said the administration was trying to strike a balance between imposing higher taxes and providing incentives to encourage investment.

Van Meurs had suggested a tax rate of 25 percent, but Murkowski settled on the lower rate to entice independent explorers and producers to the state. Democrats have suggested a higher tax rate that increases when the price of oil exceeds current levels would better protect the state against price fluctuations.

The administration argues that a tax rate that increases at higher prices would discourage investment.

“The governor decided to tip the balance more toward the incentives to increase production,” Logsdon said.

Rep. Les Gara, D-Anchorage, said the higher tax rate suggested by van Meurs is worth $350 million a year at oil prices of $40 a barrel. He said the state is still allowing the producers to take too much of the oil wealth out of the state at 20 percent and wants to hear what the oil companies’ profits margins are at a tax rate as high as 35 percent.

“If we don’t have that information, we can’t make a decision,” he said.

HOW MUCH TO EXEMPT?

Under the governor’s plan, the state would not tax the first $73 million of profit an oil and gas company makes annually in Alaska. The amount is equal to a tax exemption of 5,000 barrels of production a day on an annual basis at an average price of $40 a barrel.

The administration maintains that the provision is designed to allow small companies that currently pay no production taxes to continue to avoid taxation.

But some lawmakers say the provision is too generous—exempting half of the 14 producers operating in the state—and should not apply to the major oil companies, which reaped record profits in 2005 because of the high price of oil.

Dickinson said the exemption simplifies an existing provision allowing companies to pay no tax on the first 300 barrels produced at each well. Under the new law, the exemption is calculated by company instead of on a well-by-well basis.

“For a very small company, it will mean that they could be free and clear from paying the tax,” Dickinson said. “For the bigger companies, it’s just part of the balance between rates and credits.”

Some argue that the standard deduction could result, over time, in a proliferation of smaller companies dividing up the North Slope and trying to stay at or below the $73 million limit to avoid paying production tax.

Bonnie Robson, a consultant on oil and gas to the joint Legislative Budget and Audit Committee, suggests adding a sunset provision to phase out the deduction over five years to keep companies from dividing and trying to take advantage of the allowance.

Roger Marks, a petroleum economist with the state Department of Revenue, said the bill as written already provides protection against such efforts.

“If the commissioner sniffs that the companies are dividing up just for the tax break, he can deny it,” Marks said.

NEW VS. OLD

Some lawmakers say they’re still skeptical about the exact “crossover point” at which the state would make less under the new tax system than under the current structure. State economists have pegged that number at about $27 per barrel of oil.

The important thing to remember, Dickinson said, is that revenue to the state is declining under the current system at both low and high prices.

“With the current system, at low prices you won’t generate enough revenue to cover our spending and at high prices you won’t generate enough revenue to cover spending,” he said. “With the new system, you still don’t generate enough revenue at low prices, but you make it up at high prices.”

The state would receive $200 million less at low prices under the new system but would earn about $1 billion a year more when prices are high.

“The upside potential far offsets the low side,” Logsdon said.

CREATIVE ACCOUNTING?

Oil companies can deduct all of the costs of discovering, developing and operating an oil field from their taxable income, which raises the concern of the state falling victim to creative accounting practices and arguing over what constitutes expenses and profits for tax purposes.

Marks, the state petroleum economist, said the state has a successful track record auditing profit-sharing leases on the North Slope and would rely on what the companies claim for expenses on their federal income tax returns.

“The IRS is doing most of our work for us,” he said.

The state estimates it will cost $1 million the first year to hire the additional auditors needed to determine the industry tax debt. The cost drops to $500,000 in ensuing years.

“Taxpayers are always going to try to take advantage of whatever provisions they can in the law, that’s why you have auditors,” Logsdon said.

A HIDDEN COST?

The bill allows companies to write off the cost of decommissioning an oil field at the end of its production life. Lawmakers argue the provision could stick the state with a bill for 20 percent of the cost, which could run from $10 million to $100 million depending on the field.

Dickinson said the cost of closing down a field is the same as any other business expense and should be deductible. Gara, the Anchorage Democrat who sits on the Resources Committee, calls it a “giveaway” that should be ditched from the bill.

The companies have already recouped these costs over the years of production and now the state is taking on a huge liability it currently doesn’t have, he said.

THE ‘CLAW-BACK’

The bill includes something called a “claw-back” clause that allows companies that made Alaska oil field investments since July 1, 2001, to get a tax break on those expenditures.

Lawmakers want to know why the state is giving a tax break on investments made under the old system that are now producing significant revenue at the current high price of oil.

“They made investments under a system that gave them record profits,” Gara said. “I think that’s enough of a bonus. They don’t need a credit on top of that.”

The transitional tax break kicks in when the price of oil is above $40 a barrel and is estimated to be worth as much as $1 billion to the companies.

Logsdon said transitional provisions are standard allowances for an industry when a state changes its tax system.

“It’s part of the transition rules that occur whenever you have a change in the tax system—and this is a fairly substantial change,” he said.

ONE MORE NOTE ON GAS

The governor’s proposal replaces not only the state’s production tax on oil but also on natural gas.

The administration maintains gas should be included in the change, but lawmakers argue it’s unclear how that will affect development in Cook Inlet and other areas of the state, such as the Minto Flats and Nenana Basin.

Any negative effects on Cook Inlet producers would be offset by the incentives, Logsdon said. Although companies with multiple developments across the state—such as Chevron Alaska and Marathon—could be more adversely affected.

WHERE TO GO FROM HERE

Lawmakers could change some or all of these provisions before the bill is passed. And who knows what they will do with the information they receive from the administration in response to their questions.

House Resources Committee Co-chairman Ralph Samuels, R-Anchorage, said his committee will look closely at the bill’s incentive provisions and will likely suggest a number of amendments before passing it on to the House Finance Committee.

Senate President Ben Stevens, R-Anchorage, has a different view. He says he supports the bill as introduced by the governor because it provides the state with a steady revenue supply for the long term. He said many lawmakers are too focused on increasing the short-term revenue to the state and are missing the bigger picture.

“The overarching goal should be to increase exploration and production and attract investment,” he said.

He is skeptical of those who say Alaska can lead the way in developing a new tax regime of increased government take without hurting production.

“I’m looking at the current revenue stream that has sustained Alaska for the last 25 years and how this change is going to affect that revenue stream for the next 25 years,” Stevens said.

Staff writer R.A. Dillon can be reached at (907) 463-4893 or rdillon@newsminer.com .